Sunday Spectacle CXLIV
Long-term Industrial Commodity Price Index (real)
From The Economist,
For 150 years, commodity prices have trended ever downward. As Mr Pielke notes, a spike in prices in the 1970s prompted the famous Ehrlich-Simon bet, between an ecologist and an economist, over whether resource prices would rise or fall between 1980 and 1990. The economist, Julian Simon, argued that they would fall, as rising prices in the short-term would prompt markets to find new supplies and efficiencies that placed downward pressue on prices over the longer-term. As it turned out, he won the bet. Had it been a 30-year bet, however, he would have lost.
Mr Pielke then asks the inevitable question: are the commodity price increases of the past decade likely to trigger a similar market response, such that a decade from now we're once again enjoying a time of plenty? Or is dramatic emerging-market growth combining with dwindling supplies of critical resources to push the world against fundamental limits, the end result of which will be sustained increases in commodity prices?
To answer the question, one has to state one's beliefs in the likely path of elasticities of demand with respect to price. To put it another way: over the next decade, how successful will humanity be in substituting away from scarce resources?
(source: "Hitting our limits?" The Economist. October 14, 2011)
For investors, the issue being raised is quite important. As most know by now, commodities have been in a bull market for more than a decade (oil, as an example, hit a trough in 1998). Not only does this allow investors to make money by investing in commodities, it also greatly impacts the cost structure of the economy. The question is whether this bull market in commodities will continue into the future; or, as in the 1970's, 1940's and 1910's, trend back down.
I have been bearish on commodities for several years precisely due to the trend illustrated in the chart (another big reason I'm bearish is because prices have already run up significantly). Namely, commodities—in this case, industrial commodity prices, adjusted for inflation—have trended down in the long run. Either productivity improvements (think of soft commodities and the fertilizer revolution), new discoveries (consider the huge oil field discoveries in the 1940 to 1990 period), or substitutes (think of the emergence of plastics in the 60's) have kept a check on prices. Will this pattern repeat in the future?
The commodity bulls argue the past—big productivity improvements, large deposit discoveries, or emergence of substitutes—won't recur in the future. Some, such as Jeremy Grantham, argue that the world is running out of natural resources. Others argue that the entrance of big undeveloped and developing countries (i.e. undeveloped countries need to build up their physical infrastructure, whether it is housing, or roads, or sewage plants) portends to strong long-term demand.
Which side are you on? The debate continues...
I reckon the multi-decade long-term trend has nothing to do with investors.
ReplyDeleteThis is similar to the stock market. If you look at the multi-decade trend, you will conclude the market always go up. But that doesn't mean any time is a good time to buy stocks. And it also doesn't mean shorting stocks or allocating no asset in the stock market is contradicting to what the long-term trend is telling us.
JOHN: "I reckon the multi-decade long-term trend has nothing to do with investors. "
ReplyDeleteI kind disagree with that John. I think it comes to whether you believe in mean reversion or not.
Unlike say stocks or real estate (neither of these mean-revert since they trend up as long as the economy is growing--however their valuation (e.g. P/E ratio or P/B ratio) do mean-revert), I have no reason to believe that commodity prices will continually go up. I base this on the last few hundread years of history. Intuitively this makes sense to me since commodity price increase can negatively impact the economy (assuming you are not a commodity producer). My thinking here is mostly contrarianism (and it doesn't mean I'll necessarily be right).
So, I do think it matters whether commodities have been in a multi-decade up-trend or not. The fact that oil prices have gone up 1000%, from a low of $8/barrel in 1988 to roughly $80/barrel now, does make me think it is unlikely to continuarlly go up. Certainly, I would find it hard to imagine it going up 10x again to $800/barrel (in present value terms). In contrast, even if stocks had gone up 10x in the last decade, I can still seem them going up another 10x because their prices don't mean-revert (but their valuation does).