And once again the world is humming. World steel production hit a new all-time record in March, according to the World Steel Organisation. Global steel mills cranked out 120.3 million tonnes of steel, an increase of 30.6% from the same time last year. The WSO adds that capacity at mills in the 66 countries surveyed for its latest report is at 80.2%. That is well up from the low 58.1% in December of 2008 at the height of the credit crisis.
The task of today’s Markets and Money, then, is to ask if the rebound in global industrial production means the Global Financial Crisis is well and truly over. If that were the case, you’d want to be long commodities. As Eric Fry mentions in a note below, new financial research shows that commodity markets tend to bottom as the Federal Reserve begins tightening the discount rate.
And it’s not just rising U.S. rates that might do it. For example, later today the Australian Bureau of Statistics reports the March producer price figures. If those figures show rising producer prices, it gives the Reserve Bank of Australia more ammunition to raise Australian rates. But according to the study to be published in the Journal of Finance, that means now might be the best time to add commodities to your portfolio.
According to the Journal article, the study compared five types of portfolios: value, small-cap, momentum, growth and large-cap. It then determined how each portfolio would perform if it added commodity investments. “A 10% dose of commodities would have boosted a small-cap portfolio by the most: 1.67% per year during the restrictive period. That helping of commodities would have added 1% to the momentum portfolio, the least among the five.”
But which commodities and how much? “The study modeled allocations of 5%, 10% and 15%, and found that the 15% dose produced the best results, while 5% didn’t change the results significantly.” And the investment vehicles ranged from managed futures with an adviser to mutual funds, exchange traded funds, or index tracking funds.
All of this would seem to be very bullish. And we know that Kris, Alex, and Murray will be glad to hear this. In one form or another, all of them have recommended investments related to rising commodity prices or impending bottlenecks. Like late 2008, it seems like there’s never been a better time to be an Australian resource investor (or speculator).
Howard Simons at Bianco Research in Chicago says you should narrow your commodity search to those sectors where capital spending shortages have placed a limit on how fast output can grow. He likes the base metals. Alex likes coking coal and the platinum group metals.
Exercising some discretion about which commodities to invest in, and how, seems like a good idea. But in the big picture, the story is simple: China and India. The International Monetary Fund’s latest World Economic Outlook says that between the two of them, China and India will account for 40% of world GDP growth. China will grow faster than the rest of the G-7 combined, according to the IMF. And India will outperform the European Union.
This then, is the basic “stronger for longer” thesis in commodities that reigned in June of 2007, when Bear Stearns began quietly imploding. The “stronger for longer” theme is back. Even the Chairman of the Reserve Bank, Glenn Stevens, has caught a whiff of the optimism in the air. At a speech in Toowoomba last week Stevens said that, “Demand for natural resources has returned and prices for those products are rising. We have all read of the recent developments in contract prices for iron ore. As a result of those and other developments, Australia’s terms of trade will, it now appears; probably return during 2010 to something pretty close to the 50-year peak seen in 2008.”
Would a technician or a chartist call that a double top?
Any time you make a 50-year peak in anything, you have to ask yourself what is going. Stevens says that, “As usual with these things, we cannot know to what extent this change is permanent, as opposed to being a temporary cyclical event. However, the fact that we will have reached that level twice in the space of three years suggests there is something more than just a temporary blip at work.”
What is that “something?” Is it the industrialisation of three billion people in two of the world’s most ancient civilisations? Or has the super cycle in paper money created the mother of all commodity booms?
Either way, our deep and abiding suspicion is that the global financial system – which aids and abets leverage in the commodity markets – is as unstable as ever. The first phase of the GFC came about with a collapse in U.S. residential housing. A second stage of collapse in that sector is still possible. And there are many other risks (residential real estate and sovereign debt) to bank collateral.
But for now, none of that seems to matter. While our other colleagues have the one side of commodities trade covered – how to profit from it – we’ll take the other: how to profit from it if and when it blows up. This week we’ll be working out what the other side of the trade is. Until then…
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