Sent: 11-08-2009 12:10:03
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Global Markets: Choose Commodities
The investment gurus have spoken. Commodities is the asset class of choice.
Nouriel Roubini, the New York based economist credited with predicting the global credit crisis, and Marc Faber, the Asian-based doomsayer, were both in Australia in the past week. Roubini spoke at Diggers and Dealers, the annual resources industry confab in Kalgoorlie. Faber was speaking at seminars jointly hosted by financial services research house Rainmaker and the fund manager Treasury Asia Asset Management.
Roubini is becoming less pessimistic about the state of the world insofar as he believes that the global economy is closer to a cyclical bottom than it was six months ago. For him, we still have a recession which is likely to last until the end of 2009 but he is anticipating a modest expansion of the global economy in 2010.
Faber, on the other hand, is more of an unreconstructed pessimist. His anxiety stems from a lack of faith in the good sense of the U.S. Federal Reserve. He maintains that Fed policies got us into the mess we are in and, by following the same policies as Zimbabwe, Federal Reserve chairman Bernanke will end up with much the same results.
Interestingly, both Faber and Roubini come up with the same investment conclusion: commodities will outperform other asset classes. To some degree, their reasoning depends on the continuing expansion and restructuring of the Chinese economy. In the case of Faber, however, there is also an important connection between commodity prices and money supply.
On this point, Faber is right. This was a theme originally raised in these e-mail commentaries and in the ATC Digest more than three year ago: "For all the talk of China and India....US monetary policy settings alone would have suggested, on the historical evidence, that metal prices should be pushing to new record high levels". (Edition 32, August 2006)
When the supply of money increases by more than the amount needed to lubricate the real economy, it tends to find alternative uses with a more speculative orientation. The excess supply of capital might flow first into real estate or the stock market but after that will come art or horse racing or, along the way, physical commodities. It will keep finding more and more ever riskier destinations until the money suppliers pull back on the levers allowing the supply to grow.
In the context of the hard commodities that are important for the Australian economy, there is ample evidence of a connection between global money supply movements and movements in metal prices.
Between 2001 and 2004, OECD money supply grew by an average of 9.7% per annum. While Chinese demand is mostly credited with the subsequent hike in commodity prices, the Chinese are latecomers as catalysts for commodity price cycles. The common feature in the latest cycle as well as all modern cycles of the past 50 years has been above average money supply growth generated by the authorities in the advanced economies.
During 2007 and 2008, money supply growth rates decelerated sharply, dropping to 2.6% over the year to August 2008, leading to the normal detrimental lagged effect on metal price speculation. However, since then, the money supply growth rate has accelerated dramatically, reaching 11.7% over the year to June 2009, just as inflation was plummeting from over 4½% to less than zero. The money supply expansion in the past 12 months has been faster than at any other time over the past 40 years.
Not surprisingly, metal prices have begun to improve. Copper, zinc and nickel, for example, are up by as much as 70% from their most recent cyclical lows. This is entirely consistent with the historical relationship with money supply which now also suggests a major bubble in the coming 15-18 months.
This might not happen. Monetary authorities might step on the brakes just as quickly to cut off the excess money supply. But that would have to happen quickly to be effective. With recession still prevailing and unemployment on the rise in the advanced economies, that would be a brave step for any policy maker today. Pity the central banker who did that and nudged us into a deeper and more pervasive recession.
That leaves investors with an intriguing strategic investment dilemma. One option is to decide to participate in another potential asset price bubble, not knowing how long it will last but knowing that it will burst, in the hope that a nimble and well timed exit will deliver a good investment outcome. Alternatively, recognize that money supply growth is currently running at such unsustainably high rates that monetary authorities will move to curtail them some time in the next 12-18 months and eschew the available short term gains in favour of being well positioned to avoid the next bubble.
This email is general in nature only and does not constitute or convey specific or professional advice. Legislation changes may occur quickly. Formal advice should be sought before acting in any of the areas discussed. Be aware that the information in these articles may become innaccurate with time. Responsibility is disclaimed for any inaccuracies, errors or omissions. Particular investments are neither invited nor recommended and hence this publication is not "financial product advice" as defined in Section 766B of the above legislation. All expressions of opinion by contributors are published on the basis that they are not to be regarded as expressing the official opinion of any other person or entity unless expressly stated. No responsibility for the accuracy of the opinions or information contained in the contributor's articles is accepted by any other person or entity. Copyright: This publication is copyright. If you wish to reproduce this article you require a license, which can be purchased here, to do so.