Commodities are my favourite asset class in the current environment. If you have read this blog before, it is quite possible you already know that. I constantly find it hard to explain to people that it is very smart to own commodities, but they argue against it. I also do not understand why many people hate this asset class, so I thought I would answer some common myths about the current commodity secular bull market... let us start!
1. Why invest in commodities when they follow stocks?
During bad economic conditions, like we are experiencing in current times, clueless investors will tell you that high commodity prices are not sustainable and that you would be crazy to consider investing into commodities as they fall with stocks. On top of that, media will try and brainwash you with the risk on / risk off correlation talk, so majority of retail investors will think that as soon as the economy slows and stocks start falling, commodities will crash too. But that is far from truth. Commodities have been great performers during current turmoil and that has always been the case throughout history.
The chart above shows that commodities do amazingly well during the periods where secular bear markets create sideways trading ranges in the stock market. So in other words, commodities do amazingly well during the periods of awful economic growth, during either high inflation or deflation, during debt problems and during periods when governments and banks fall apart. Commodities do well during constant recessionary periods like the economy experienced in 1900s/10s, 1930s/40s, 1960s/70s and 2000s/10s. Whenever global economies where in terrible shape - commodities did great - not the other way around.
Sure, commodities experience cyclical bear markets and corrections during their secular rises. For example Crude Oil has fallen by more than 50% over three times in a recent decade. However Brent Crude is still up 11 times in a 11 years. Silver has crashed many many times by over 25 to 30% and during 2008 it crash by almost 70%, and it is still up over 8 times since a decade ago. That is how markets work and that is why you should buy low like a contrarian.
2. "They say" the commodity bubble is about to pop?
What bubble? So many people have no idea what they are on about and even less ability to detect a bubble. "They" call everything a bubble - every week new asset class is in a bubble according to CNBC or some random deflation blog. So what is actually a real bubble? A real bubble or a speculative mania is something everyone talks about regularly, but not only that. Bubble is something that everyone talks about and owns (buys and sells), but not only that. Bubble is something that everyone talks about, owns and is making money on constantly because prices only go up. If you really want to understand what a real bubble or speculative mania feels like, instead of just stupidly throwing that word around everyday, you should watch a four part episode by PBS from 1997 on the Nasdaq Bubble (Article: The Greatest Bull Market Bubble Of All Time). I highly recommend it!
Look at the chart above, showing the asset portfolio of an average millionaire around the globe. How many of them do you think own Gold, Rice, Crude Oil, Sugar or a Commodity index fund? How many people do you know who own Soybeans right now? Do you know any farmers who have been making a killing on the farm season after season after season? No... agriculture has been an awful sector of business for 30 years.
Today, farms are deserted places. UK farmers have the highest suicide rates in the world. Many hundreds of thousands of Indian farmers kill themselves everyday as they go bust. In Japan, farmers are over 68 years old as young people have all moved to the city and refuse to work on farms. In other Western countries many young people attend university getting business and law degrees. How many young people do you know who have studied Agriculture? When I finished high school in 2001, every one of my friends went to study IT. Today we have nothing like that in the commodities boom. How can that be a bubble?
How many pension funds do you know who own Gold? And what is their weighting towards it... 1% of the overall portfolio? Probably even 0.5%. I bet majority of the people reading this do not actually own any Gold or Silver, let alone other commodities. How many friends of yours are talking about Rice or Coffee, let alone making money in it? Don't believe me, get of your computer and go attend some investment forums. Ask some people what they own or have recently invested in. Less than 10% of people on average own commodities and they aren't really making a ton of money on it year after year, like during the Nasdaq bubble.
During the period between 1996 and 1999, so many people where making money on Tech stocks they never even knew anything about. The whole world was gambling in Tech stocks, buying and selling everyday and making a ton of money. The whole world lost the plot. Silicon Valley programers became millionaires overnight... for doing nothing. Lets compare Gold and Nasdaq in the chart above. How is Gold anywhere close to the Tech bubble? Calling Gold a bubble or a mania is actually a total non sense!
3. What will end the current commodity boom?
Well obviously it will be the final bubble stage. That's right... commodities will one day soon enter a bubble, just like stocks did in late 90s. That might be in a few years from now or that might be in several years from now. I cannot tell you when it will happen, because I am not a prophet. When you see people gambling in Gold and Silver as it spikes to insane levels on daily basis, like Nasdaq did in late 1990s (go and watch that PBS video), you will know we are close to the end of the run.
Also look at the first chart. Going back about 300 years of history, the shortest secular bull market for commodities was 15 years, while the longest was 21 years. The average is about 17 years or so. If we assume that the commodity bull market started in 1999 or even 2000 - as seen in the chart above - than we can say the current secular trend has lasted about 11 to 12 years. That means commodities could rally for at least a few years more as a worst case scenario or a decade as the best case scenario.
However, I could also tell you what will end the boom or at least signal that the end is near - demand and supply. I commonly hear this... "my friend who follows markets said to me Oil is in a bubble because US and Europe are in big trouble. You should also short Oil like me because it will crash due to economic recession and deflation." No offence, but your friend is an idiot and so are you. Yes I agree that Oil collapses for awhile when we have economic pain, but Oil is up 11 times since 2000 and S&P 500 is up 0 times... so yes your friend is an idiot.
US, EU and UK have almost nothing to do with the Oil market as well as the overall commodity sector. It is the rest of the world, including the 3 billion people in Asia, that are in control of the rising demand and therefore the price of commodities. This is where the action is, this is where the growth is and this is what is setting the tone to the current secular bull market. There is a whole new world growing in the East, but the US and EU centric economists and investors fail to recognise this. They constantly point to the US consumer or the US Oil demand or the US GDP growth as a barometer of everything on our Earth. That is, once again, non sense. Asia is consuming the Soybeans, Crude Oil, Copper, Sugar, Cotton and Rice. Asia needs more Corn, more Natural Gas, more Uranium and their central banks need more Gold. Asia is starting to like chocolate so they want more Cocoa and they are starting to drink Coffee regularly like Westerns do.
Part II of the post will be covered later in the week, including the Supply side shortages that "no one" seems to see.