Here's why most experts are wrong on commodities

Sep 8, 2011

In this issue:
» Nassim Taleb's latest revelation
» Auto industry may face demand blues this festive season
» Look what's really driving gold prices
» Euro crisis could be bigger than Lehman collapse, feels Soros
» ...and more!
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The developed world, most of all the US, seems to have tried every trick in the book. But their economies seemed to have fallen into some sort of inertia. They just refuse to abandon their sluggishness. In such a situation, most experts in the economic world are assuming prices of assets as well as goods and services to fall across the board. This is what is known as deflation. It takes place when available money or credit in the system comes crashing down. And what would be the favourite candidate to deflate or more simply put, to come down in price? Well, commodities we believe as no asset class appears to have had a better run than them in the past decade.

A gentleman who goes by the name of Chris Martenson begs to differ from this point of view however. The man may not be a household name. But it never hurts, we think, to hear differing viewpoints on the same subject. So, what arguments does Mr Martenson have in favour of continued strong prices for commodities?

Mr Martenson is of the view that while credit has indeed fallen, it will be wrong to lump the credit in financial and non-financial markets together. The fall in credit seems to have happened only in the financial markets as per him. And this will have an impact only on paper assets such as stocks, bonds, derivatives etc. The non-financial credit on the other hand has only risen in the past and this has led to more consumption, leading to more demand for commodities.

This is not all. Martenson also believes that supply in commodities is unlikely to exceed demand as some people are predicting. This is because while GDP growth in China and India will slow down, it will not certainly witness negative growth rates for a long time to come. Thus, the impact of more than two billion citizens in these countries demanding more products will be hugely positive for the prices. Infact, he has argued that never before in history, have so many people come together to create so much demand for the finite resources of this planet.

Martenson's arguments do indeed make a lot of sense. As a matter of fact, he is not the only one predicting commodities to be in a long term bull run. Other renowned investors like Jim Rogers and Jeremy Grantham have also toed the same line. While commodities as an asset class is not fully understood by us, it is difficult to argue against the case put by Mr Martenson and other successful investors. Thus, this reality has to be kept in mind while analysing companies. Only those that have the pricing power and real intent to improve productivity will be able to avoid a dent in their profitability we believe. For others, volatility in operating margins could be the order of the day. And as investors, identifying the former from the latter will most likely determine how we fare in our stock investments.

Do you think commodities have entered a period of permanently high and rising prices? Share your views with us or you can also comment on our Facebook page.

 Chart of the day
Continuing with our theme of commodities, today's chart of the day highlights nations that are sitting on a fortune of metals and minerals. As shown, South Africa, with reserves in the region of US$ 2.5 trillion tops the list. India, with metal and ore reserves in the region of US$ 300 bn is ranked 11th in the list. Nearly 86% of those however, are believed to be iron ore reserves.


Nassim Nicholas Taleb, author of the famous book 'The Black Swan' has pointed out some very startling facts and figures that pull the towel off American banking system. In fact, you will also understand why the US financial crisis happened in the first place and why it could very well repeat anytime in the future as well. The intriguing thing about these American megabanks is that no matter what they do, their bank accounts keep filling up. When things go fine, they get paid for the upside. When things turn sour, as they did since the burst of the US housing bubble, bankers are salvaged by helpless shareholders and taxpayers.

Getting back to Mr Taleb, can you guess the amount of money that has been paid to US bankers in the past five years? The figure is a staggering US$ 2,200,000,000,000 (2.2 trillion), a little less than two times India's Gross Domestic Product (GDP). Mr Taleb estimates that the same could rise to about US$ 5 trillion in the coming decade. Yes, this is the amount that would find its way into the personal accounts of bank executives and employees in the form of pay and bonuses. It is worth mentioning that the bankers' compensation last year was back at its pre-crisis level, despite the faltering US economy. Can there be a more perverse form of democracy and capitalism? We doubt!

Can the origin of the recent big rise in gold prices be wholly attributed to the US and European debt crisis? So far that certainly has been the case. The perception was that because of the money printing policies of the US Fed and Europe, their currencies would lose value and so investors were flocking to gold. But a closer look at who is really buying gold will give an indication of what is really driving gold prices. For instance, demand by what could be termed professional investors has been largely unchanged, as shown by holdings in exchange traded funds and futures contracts. The real demand growth for gold has largely come from consumers in China and India and from central banks.

Now, why is that? Presumably, Indian and Chinese consumers are flocking to the precious metal because they see it as a hedge against high inflation in their respective economies. Moreover, with a rise in their incomes, additional demand is created for gold, which also acts like a status symbol. Therefore, it does not seem likely that they are buying more of the metal because of the debt crisis in the US and Europe. Does that then mean that if inflation in India and China moderates, gold will not be able to extend its gains? Or will investors in the developed economies see the significance of gold in these times of crisis and buy more quantities, something which they are not doing now? One will have to wait and watch.

Well, 2012 may or may not be doomsday for Planet Earth. However, it may very well be doomsday for the global financial system. According to ace investor and billionaire George Soros, the European debt crisis can inflict more damage to the system than what the Lehman Brothers' collapse did. The heavy government debt burden in periphery countries like the PIIGS could set off a bank failure across the continent. This contagion could then spread to the US and other financial markets. While the US had the Fed to try and bring order to the chaos, in Europe there is a lack of any pan-European body to handle a banking crisis of such gravity. Thus, chances of a double-dip recession cannot be ruled out just yet.

The current year may not be a repeat of last year's boom for the Indian auto industry. Last year's festive season saw the industry expand by a whopping 46%. However, the higher interest rates combined with the high price of fuel would end up playing a dampener on this year's show. Most passenger car manufacturers feel that the sluggishness in sales that the industry has been witnessing in the recent months would continue into the festive season as well. Even the industry's main body SIAM (Society of Indian Auto Manufacturers) has expressed its doubts that the industry sales would see a revival. As a result, there are chances that the industry body may have to revise its full year growth estimates downwards. SIAM has already revised the sales growth forecast for the current fiscal year to 11-13% YoY from its earlier estimate of 12-15%.

If the festive season does not bring about any cheer then the growth forecast maybe further revised downwards. Unfortunately with inflation continuing to trend upwards, there is very little probability of interest rates coming down in the near future. And with the global crisis, oil prices may not ease either. As a result, the woes for the auto industry would continue for quite some time to come.

Meanwhile, indices in the Indian stock market have chosen to jiggle around the breakeven point today with the Sensex trading lower by around 36 points at the time of writing. Heavyweights like HDFC Bank and RIL were seen adding maximum selling pressure. While other Asian indices closed mixed today, Europe is trading mostly in the negative currently.

 Today's investing mantra
"Our experience has been that pro-rata portions of truly outstanding businesses sometimes sell in the securities markets at very large discounts from the prices they would command in negotiated transactions involving entire companies" - Warren Buffett

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4 Responses to "Here's why most experts are wrong on commodities"


Sep 9, 2011

the benefit of a rise in price is more than a rise in volumes. even as capacity increases, companies globally will want to curtail production, which is being seen in most of the man made commodity sectors globally. unless demand falls off a cliff, commodity prices will likely remain high.



Sep 8, 2011

I fully appreciate Radha's views. If India and China declare their policy statements in curtailing commodity usage, oil will nose dive. Oil consumption is very recent phenomena and largely driven by highly ineffient consumption (less mass transportation, erratic power utilities etc and not on account of climatic conditions like in western countries) which over a period of time change to a large extent in India.



Sep 8, 2011

The prices of commodities can only go up till the end product making can remain profitable for businesses and affordable for the consumers. though the number of consumers is very large, their per capita income levels are still very low. so commodity prices will have to take a dip



Sep 8, 2011

Views on future trend of the commodity prices.

Mr Martensons reasoning that India & China's growth and consumption shall drive the commodity prices north is to be viewed from other angle also.

What is the commoditties consumption break up as between developed economies & developing economies Still overall consumption of most of the commodities is much more in absolute terms in developed economies. How the consumption of commodities shall be effected in developing economies. If they decline then commodity prices could go south as well.

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