Much has been said and many charts have been plotted to prove
that the commodity "supercycle" has run its course. The days of
$1,800 gold, $150 oil, and $18 soybeans have passed. But before we
write this group off, we should first understand that placing them
all under the umbrella of "commodities" limits our ability to
analyze this wide range of products and resources.
To borrow a phrase from
Raymond Carver's 1981 collection
, what we talk about when we talk about
as part of our grand investment theses needs to be defined. In
addition to his phraseology, we can also learn from Carver's
philosophy; he was by no means a sentimentalist: Don't get married
to a concept. Deal in the reality of supply, demand, and capacity.
The Commodity Research Bureau's commodity-tracking index (CRB) is
the oldest and still the basic benchmark for commodity indices in
the world. There are currently 19 components ranging from the
obvious (like oil) to the obscure (like tallow and rosin). It
slices and dices the sectors, but after its tenth makeover (the
revision in 2005), we are left with four major groups: energy,
agriculture, precious metals, and base metals, whose weightings
better reflect the importance of energy and agriculture, now
representing 39% and 41% respectively.
Across these groups there are a variety of input/output economic
forces that have led to a wide diversion in price performance. And
the price of the underlying commodities has a wide and variable
impact on the profitability, and therefore the share price, of the
companies that produce, sell, or use these materials.
Consumable Vs. Recyclable
I like to break these products into two main categories: those that
are consumable and those that are recyclable. For example,
commodities such as copper and iron not only have a fairly
predictable and expandable production capability, but can also be
The chart below shows the price comparison of copper and oil as
measured by their respective ETFs.
As you can see, both crumbled in late 2009 as the financial crisis
took its toll and as global growth contracted. But within months,
oil started to outperform by a wide margin. And this came despite
China's continual production and hoarding of copper (among other
metals, such as steel) in its attempt to maintain massive
infrastructure spending and growth. China soon became the world's
largest producer and supposed consumer, reaching nearly 40% of
worldwide supply of the industrial metals -- a completely
disproportionate amount relative to the actual demand. China's
reluctance to shutter plants resulted in ghost cities but failed to
prop up prices as lower-cost recycled material found its way back
onto the global marketplace. Copper and iron prices coud remain
under pressure for years to come. This does not bode well for firms
Oil, on the other hand, quickly rebounded and has held steady,
albeit below peak prices, even as demand has remained muted. The
reason is that oil is a consumable, and all the talk of the shale
revolution aside, is becoming increasingly harder to find and
produce. In fact, the shale and fracking revolution might be coming
to end before it even had chance to fully be exploited.
Currently, due to a lack of infrastructure and a means to refine,
distribute, and consume the product, an increasing amount of gas is
being burned at the tip, flared, than used. At the moment, nearly
all the new basins have wells that are burning gas; the number of
flaring permits has more than doubled to 630 in 2012 from 303 in
2010. It is estimated that some 30% of the gas produced in North
Dakota is being burned off wells waiting to get connected to
known (pun intended) that the most productive period of any drill
site is early in the lifecycle. Depletion rates run between 40-70%
year-over-year, and it will take more and more continuous drilling
to maintain current production levels. Drillers have focused on the
sites with the greatest potential and will now move down the curve
to less promising locations as time passes.
There's no doubt shale and fracking are adding significant supply
but when all is said and done, this might be a single generation
play. We may soon be back to talk of peak oil/gas and the steady
march of higher energy prices. So let's not raise the victory flag
on a permanent state of energy independence quite yet.
The companies best positioned to benefit from energy growth should
be those providing the equipment for exploration, such
The other area that I have a long-term bullish outlook on is the
agricultural sector. I'm not talking about buying soybean or corn
futures, which can be accommodated through exchange traded funds
Teucrium Soybean Fund
Teucrium Corn Fund
(NYSEARCA:CORN), but rather the fertilizer companies. While price
of the underlying crops can vary widely year to year depending on
the season's production, the long term demand to boost yields,
shorten growing cycles, and make crops more resistant to fungus or
disease remains on a steady rise.
Though there seems to have been a pause in recent years, the growth
of the middle class among emerging markets such as China, India,
and Eastern Europe is inevitable. Along with the trend toward
urbanization comes the desire for a diet higher in protein. With
corn and soybeans the main feed for cattle, pork and chicken
companies such as
(CF) stand to benefit.
The map of how corn (maize) yields have been stagnating across Asia
and Latin America shows the need to boost production.
The three names above, along with
(IPI), all took a hit in early August, tumbling some 25% each on
news that Russian-based OAO Uralkali -- the world's largest potash
producer at nearly 20% of global production -- was breaking off its
partnership with Belaruskali, citing a violation of their export
agreement. Together they accounted for 43% of global exports. This
seems to be a gambit for Uralkali to grab share, particularly of
exports to China, and has lead to concerns that a pricing war would
soon be underway. But there seems to have been some fence mending
in recent weeks.
In either case, low-cost producers such as Potash stand to benefit
not only from scale, but also from the opportunity to further
consolidate the industry.
A recent move by
(BHP) seems to sum up the story of direction and bifurcation of
commodities. BHP, one of the largest miners of copper and iron, has
been shedding some of those assets in Australia. It is planning on
investing $2.9 billion to develop a potash mining facility in
Saskatchewan, Canada. It expects be able to mine the Jansen project
for the next 50 years, and views it as a way to profit from the
rising global demand for food.
When it comes to commodities, think consumable, not reusable.