Declining Commodity Prices: A Trend or an Economic Fact of Life

Everything keeps going up. JP Morgan has increased its target for the ASX/200 from 5,930 to 6,520, and none too soon! The local index was up nearly three percent. It will have to do better than that if it’s to resume its pattern of leading the Dow, which was 6.2% in April. Despite all the risks, stocks are “in the zone.”

You can imagine what it must be like to be a short-seller right now, assuming that stocks will return to trend or are overvalued. You’d be getting crushed, psychologically as well as financially.

More importantly, short-sellers are also being forced to close out their short positions, buying back the shares they sold forward. This, of course, ads even more upward buying momentum to share prices. But it also means we may be reaching the end of this phase of rising brilliance.

When there are no short sellers left, when all the bears have been shamed, humiliated, and publicly mocked, well then, THAT’s when you want to go short, or at least expect the big crash. So while the bears surrender, capitulate, and otherwise throw up their paws in submission, we will turn to a meatier question: are commodity prices really going to go up for another 20 years?

“There is a real possibility that following a 200-year lasting decline in commodity prices in real terms, commodities-including farm products-will appreciate in real terms for many more years. If this were indeed to be the case, it is conceivable that, as on past occasions, some countries, regions, and cities could reach a higher per capita income than the U.S. or Western European countries,” reports Dr. Doom, Marc Faber in his latest Gloom, Boom, Doom report.

This is the argument we have been inching our way towards for the last week. Today we take a great mental leap forward to see what it really means. “Russian economist Nikolai Kondratiev argued in the 1920s that commodities move in 50-60 year cycles… .Now investors Shane Oliver and Marc Faber are using Kondratiev’s theory to back their bets that the 5 and a half year-old rally in commodity-related stocks is only just the beginning,” reads a Bloomberg story today.

There is certainly some evidence that basic commodities like grain and metals reached 200-year lows in the first few years of this century. But this prompts an obvious question: is a 200-year trend merely a trend… or a kind of economic law? If it’s a trend, then it will eventually end and in a reversal. In this case that would mean rising commodity prices for years on end.

But as a thought experiment, lets take the other side of this trade and ask what happens if declining commodity prices are not a trend but an economic fact of life, a kind of law. If declining prices for tangible goods conforms to a kind of economic law, then you could restate it simply and say that commodities get cheaper over time. Technology makes finding them and producing them increasingly less expensive.

We’ve quoted below some more thoughts on the matter from Julian Simon. Simon is one of great advocates of the idea that resources decline in price over time and actually become more available, not less. It’s worth a read, especially since its at odds with so much conventional wisdom.

Take a look at Julian Simon’s book “The Ultimate Resource Two: People, Materials, and Environment“.  It’s a long one. So here’s the short version of his argument that resources are getting cheaper and more abundant, not scarcer and more expensive.

“Humankind has evolved culturally (and perhaps also genetically) in such a manner that our patterns of behavior (with social rules and customs being a crucial part of these patterns) predispose us to deal successfully with resource scarcity. This view of human history is consistent with the observed long- term trend toward greater resource availability, and with the positive (and growing) preponderance of our creative over our exploitational activities.

“This view provides a causal foundation for the observed benign resource trends. It argues against our being at a turning point in resource history now, and thereby buttresses the technique of simply extrapolating from past trends that produces forecasts of increasing rather than decreasing resource availability. That is, our evolved patterns have given us greater rather than less command over resources over the centuries. The market system is part of that evolution, of course. But it is not the whole of it.”

“The story of Robinson Crusoe (which has been badly twisted by economists, who make it a story of allocation when it is really a story of ingenuity and the use of the knowledge that he brought with him) also illustrates this point, e.g., that by this time we have developed a body of knowledge and a set of patterns which allow us to improve our resource situation rather than make it worse, even as we use resources and even in the absence of an exchange mechanism.

“Thus, I think we can with confidence expect to observe greater rather than less availability of resources with the passage of time, whether it be arable land or oil or whatever, just as we observe in the trends in the past. If I am correct, we now have systematic grounds to believe that we are not at a turning point in resource history caused by man’s propensity to destroy rather than create. Rather, humankind is on balance creator rather than destroyer.”

Amen to that. We hope it’s true.

Dan Denning
Markets and Money

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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