Boomtime for commodities

Business Times - 04 Mar 2006

OVERVIEW

COMMODITY markets are bullish - and have been for at least five years. Are we near the end of the upward cycle, or is it just beginning? This week we bring together some of the best brains in the business to answer those questions and to tell investors where they should be putting their money if they want to profit from the commodities boom.

PARTICIPANTS

in the roundtable

Moderator: Anthony Rowley, BT Tokyo Correspondent

Panelists:

• James ('Jim') Rogers, head of his own commodity investment firm, Rogers Holdings, and a global expert on commodities. He is a former co-investor with George Soros
• Marc Faber, investment adviser and publisher of the 'Gloom, Boom and Doom Report'
• William Thomson, chairman of Private Capital Ltd, Hong Kong and senior adviser to Franklin Templeton Institutional Hong Kong and Axiom Opportunities Fund, London

Anthony Rowley: We're pleased and privileged to have world-renowned commodities expert Jim Rogers joining us today - along with two old friends and savants of the investment world, Marc Faber and William Thomson. A warm welcome to you all.

Jim, I know you have insisted that your two-year-old daughter, Happy, should become bilingual in English and Mandarin, because you believe Chinese is the language of the future - and also that you have already put her into commodities. Is that because you think commodities are the investment of the future?

Jim Rogers: I just wrote a whole book on the subject. Historically, every 25 or 30 years we've had a long multi-year bull market (in commodities) followed by a long multi-year bear market. In my view, we're now in a new bull market. If history is any guide, this bull market will last until sometime between 2014 and 2022. That is not a prediction - just a reflection of past historical cycles. Essentially (what is driving it) is the imbalance of supply and demand similar to imbalances that have recurred regularly for centuries.

Throughout history, there have been bull markets in raw materials every 20 to 30 years. Supply and demand regularly get out of balance, leading to recurring periods of rising (and declining) prices. Virtually no one has built an offshore drilling rig, or opened a lead mine, or developed a sugar plantation during this period. Quite the opposite; productive equipment has deteriorated, been cannibalised, or scrapped while other capacity has closed.

Raw materials should always be represented in any diversified portfolio. Stocks, bonds, cash and real estate do not provide sufficient representation of the world's economy, nor sufficient non-correlation to each other.

Anthony: Let's talk about the background to the current bull market in commodity prices, and where we see it going from here. Marc, what's your view?

Marc Faber: Commodities were in a more than 20-year bear market between 1980 and 2001. Since then, industrial commodity prices especially have risen sharply as the incremental demand from China shifted the demand curve to the right. However, inflation adjusted commodity prices are still very depressed. This would especially apply to the agricultural commodities.

Usually, commodity cycles, also known as Kondratieff cycles, last 45 to 60 years from peak to peak. Since the last peak was in 1980, I would expect this cycle, which began in 2001, to last until between 2025 and 2040.

William Thomson: Each decade seems to have an overwhelming investment theme. The Eighties were all about Japan and in the Nineties it was high-tech. I expect the 'Noughties' to be the decade for commodities. After a 20-year bear market from 1980 to 2000, commodities should enjoy a recovery period that should last at least 10 years and could extend to 20 years.

It is powered by the totally mind-blowing growth in demand that is coming from the world's emerging economies led by India and China. The industrialisation of these two population giants is leading to the greatest shift in global economic power since the industrialisation of first, Great Britain 200 years ago, followed by the United States 100 years ago.

To put this in perspective, in 1820 Asia represented about 40 per cent of world GDP. By 1950 it had fallen to 18 per cent and has since recovered to over 30 per cent. The Asian Development Bank and Harvard estimate that Asia's share of world GDP should be over 40 per cent again by 2020.

So, in fact, Asia is just in the process of reestablishing its historic place in the world economy. This is the vital underpinning to the commodity demand bull story. Supply inevitably lags in its response to these increased demands in the early years.

Anthony: Which commodities do you feel hold out the best promise for further price gains - and why?

Jim: I would be doing research in the agricultural area as this is where there may be new opportunities. Many of them (agricultural commodities) are still far, far below their all-time highs while the fundamentals are changing for the better.

William: My knowledge is of the energy and minerals markets and, as noted, I believe there is plenty of opportunity there in the coming years. The soft commodities have lagged but I suspect they will now play catch up. After all, there has been the same lack of investment in these assets for many years while demand grows in the emerging economies.

Institutional funds will also increasingly try to access these commodity markets as they seek to diversify away from overpriced equity and fixed income markets.

Marc: Grains are the most inexpensive commodities. They are at a 200-year low against oil. I also think that gold and silver are still very inexpensive, when compared to the US dollar and to the Dow Jones Industrial Average.

Anthony: Talking of that, Marc, how much further do you think gold, platinum and silver prices have to go in this cycle?

Marc: In your lifetime, I believe investors will be able to buy one Dow Jones Industrial Average with less than five ounces of gold. So, depending on how much money the US will print, gold will either outperform equities on the upside or decline less than equities in a bear market. My target is for gold prices to rise to between US$5,000 and US$10,000 in the next 10 years.
Anthony: Are you equally bullish on these metals, Jim?

Jim: In bull markets, nearly everything eventually goes to a new all-time high and usually multiples above the old all-time highs. Gold and silver should too. Platinum is already there, but if you adjust its old highs for inflation, it too might have further to go over the course of this long bull market. Ask me again in 2018.

William: Much depends on how the growing geopolitical dangers develop in the coming years. However, even without significant global disruptions, I have stated before that US$1,000 an ounce gold should be attainable and, if we have major problems with war or inflation, then US$2,000 to US$3,000 can be envisaged since it would only be the equivalent of US$860, the high in 1980, in today's money.

Along the same lines US$20 to US$30 silver and US$100 to US$150 oil seems possible over the next half decade. It could even be worse if we fall into a situation where nuclear weapons are being used.

Anthony: All well and good, but commodity markets have been rather volatile lately, which may scare off some investors. What's behind this?

Jim: Nothing goes in one direction all the time. There are always corrections and consolidations in every bull and bear market in every asset class - especially in the long secular markets on which I try to focus. For example, in the long stock bull market from 1982 to the end of the 1990s, shares went down 40 per cent in 1987 and had other serious setbacks in 1989, 1990, 1994, 1997, 1998, etc, yet the secular trend was up. Things that shoot straight up for a while are especially prone to consolidations and need them to ensure the bull move lasts a long time.

William: Bull markets tend to run in phases moving from complete indifference or even revulsion to the class, as happened with commodities at the end of their 20-year bear markets around 2000, through disbelief as prices crawl off the floor amid early professional accumulation, and then a gradual recognition that circumstances have changed.

This, in turn, generates further speculative interest and flows both in the financial markets and real investment. Finally, the public is convinced that we are in a new perpetual bull market and a new way for everyman to secure his financial future is upon us as happened at the end of the dotcom, high-tech boom in the late 1990s as the last commodity bear market was finishing.

We have had two years of strong commodity markets, especially energy and minerals, on the back of surging demand from emerging economies and a recovery in the US with little or no increase in supply. The growing enthusiasm for the class has generated an over-bought situation short term and the need for a normal consolidation of prior price gains in the face of a maturing economic recovery in the US where the Fed has been increasing interest rates for over 18 months.

This is perfectly normal as the market digests the gains and attempts to assess supply and demand balances going forward. Geopolitical considerations will play an important role in this process as countries such as India and China attempt to assure future access to oil and other commodities in a less stable world where the US seems increasingly willing to pay any price to try and assert its hegemony over the Islamic world.

Once this period of digestion is over, then I expect prices to move up again. This could happen any time if the conflict between the US and Iran escalates in the coming weeks and months, as I fear it will.

Marc: As in other asset markets, approximately 20 per cent of the price gains can be attributed to speculative demand and not end-user demand. Speculators began to take some profits and, therefore, prices of aluminium, zinc and lead have come off by respectively 13 per cent, 15 per cent and 19 per cent from their highs. In addition, it is likely that industrial commodity prices underwent some kind of short squeeze recently - this especially for copper.

Anthony: How can individual or 'retail' investors best access these markets?
Jim: Academics, consultants, and banks have confirmed repeatedly that index investing outperforms active investing 80 per cent of the time year after year so stick with a good index. If you find a great active manager, give him your money and introduce him to me too. The chances we will find that manager early are very slim. If an investor knows a great deal about a commodity or commodities, he can invest himself after he has done a lot of homework.

Anthony: You have developed your own commodities index, the Rogers International Commodity Index. This is not an investment fund as such but it does provide investors with a way of gaining diversified exposure to the markets. Can you tell us a little more about it?

Jim: The Rogers International Commodities Index (RICI) was designed to meet the need for consistent investing in a broad-based international vehicle. Thirty-five commodities are represented in the RICI. This gives it breadth just as the S&P 500 is broader than the Dow Jones Industrials. International commodities are represented, whereas most other indices are regional or US-oriented. For example, other indices exclude rice, the staple food of a large percentage of the world. All commodities in the RICI are publicly traded on recognised exchanges to ensure ease of tracking and verification.

Anthony: Marc and Bill, how do you recommend accessing commodity markets?

Marc: For the individual investor, the easiest is to buy precious metals including gold, silver and platinum. There are certificates on other commodities but the costs associated with these certificates are fairly high. All commodities can be bought in the futures market and individuals could also buy shares of companies involved in oil, gold, uranium and plantations.

William: The investor's knowledge base will affect his chosen instruments. Some will want to invest directly in the producers such as the oil and mining majors, for instance, Exxon and BHP Billiton; some the juniors and the explorers while others will prefer to go through mutual funds and investment trusts. The more speculative might even try to invest directly in commodity futures - not that I am recommending they try it.

These are the traditional investment instruments. However, today we are fortunate in having others, especially exchange traded funds (ETFs), hedge funds and funds of hedge funds. Dozens of ETFs are available in the US and elsewhere. The number is expanding all the time. Some that are of interest just track the gold price and, shortly, silver. Another is the Goldman Sachs commodity index and yet another an index of the oil majors. They are an efficient, low cost way to invest on a trend.

Hedge funds and funds of hedge funds promise diversification and reduced volatility since they can go short as well as long and can invest over a variety of strategies, for instance, commodity trade finance, that are not available to the individual investor but promise steady above average returns. For some investors they will represent an important opportunity within a diversified portfolio.

Anthony: Any other comments, gentlemen, on investment in commodities?

Jim: The same as for every investment. Do nothing unless and until you have done a lot of homework. I might add that Singapore should be developing commodity markets of its own. I hope it will.

William: As with all investment themes I see commodities eventually going to excess levels, driven by speculative institutional funds. I also expect it to be a much more volatile ride than it has been to date.

Marc: International tensions are rising and nothing drives commodities as strongly upward as a war.

Anthony: And on that rather sobering note, we must end. Thank you all again for coming - and may your pickings be rich!

KEY POINTS

• This is 'the decade of commodities', suggests one of our experts while another suggests that the bull market could run for another 15 years, or even longer due to a multitude of factors.
• Investor favourites such as gold and silver still have a long way to go, in the consensus view among our experts - but the shrewd investor will also want to look closely at agricultural commodities (such as grains and others).
• Do not be scared off by commodity market volatility - 'nothing goes up in a straight line', as one market veteran suggests. But be wary of entering the commodity markets (as with any other investment arena) without doing your homework, he advises.
• The potential rewards of investing in commodities, even at this stage of the cycle, are great - but so are the risks for the unwary.