We were expecting the parabolic move in commodity prices to be interrupted by a correction at some point. While it could not have been anticipated as the catalyst for a pullback, the catastrophe in Japan two weeks ago prompted a sizeable sell-off in risk assets, including commodities. The question is whether in the aftermath of this event, or other lingering concerns, commodities can restart a substantive move to higher levels.
We believe the commodity markets are in the midst of a multi-decade super cycle. This can be thought of as a period over which the commodity complex is in an extended bull market that occasionally will be interrupted by temporary corrective phases. We date the beginning of this cycle to roughly 1999 and expect it to last fifteen to twenty years or so. Therefore, declines like happened recently are to be thought of as buying opportunities. However, what may be most appealing to purchase within the commodity complex can rotate from energy, to base and precious metals, and to the grains like corn and wheat.
For instance, uranium was damaged the most by the shock in Japan as anxieties increased about nuclear energy's future and the stability of existing nuclear fleets in countries around the world. Meanwhile, oil prices barely wavered as tensions in the Middle East and North Africa kept concerns of a supply shock elevated and prices well bid. So rather than a uniform commitment to commodities that does have long-term strategic appeal, a tactical approach would dissect the components of the entire complex to find those that offer the most appealing characteristics at a given point in time.
The economic impairment inflicted on the global economy from Japan and the spike in oil prices at this juncture has not altered the expansive phase in global activity we are currently experiencing. Clearly, were oil prices to move higher - perhaps approaching $125 or more a barrel - a slowdown might be expected which could hurt commodities and other risk assets alike. But if those levels in oil were to be achieved, it would also be somewhat self-limiting because the whiff of a softening in economic conditions would likely take some vigor out of energy prices. If this were to transpire linearly, it would allow economic activity to pick up speed again and with it advancing commodities.
Areas of interest within the commodity markets include energy, but also the base metals market which includes copper, iron ore and aluminum. China's importance to the commodity food chain cannot be underestimated given its formidable appetite for "stuff" that feeds its infrastructure build-out. Here there are some concerns as China is in the midst of slowing down its economy to temper inflation and property prices. The base case that we subscribe to is one in which China's economy and property market slows without endangering its expansion. Yet, the prospects of a policy error triggering a hard landing have to be considered. At the moment, it appears Chinese policymakers are engineering a gradual take down and that should keep commodity markets from panicking.
Precious metals have moved higher, to records in the case of silver; while others like gold, platinum and palladium have moved up as well. Gold is attractive as the backdrop of liquidity, firming economic conditions, and geopolitical unrest form a supportive floor under the perceived value of bullion. The white metals, silver, platinum and palladium, move on some of the same underpinnings but also get an up leg from their industrial application which increased global trade should support.
As for the grains, weather-related activity triggered a sharp spike in prices in the second half of 2010. Levels today offer a much more reasonable entry in a space that has excellent long term potential. It has been estimated that there will be a need to produce 70% more food to feed the world's population, expected to be 9 billion, by 2050. If that proves to be directionally accurate, even if not exact by order of magnitude, soft commodities have room to grow.
Overall, the premise of global growth continuing to expand should allow for resumption in the bull market for commodities to begin anew. The potential gains from exposure to this area are appealing for investors with a time horizon sufficient to allow the winds of the super cycle to fill the sails.