From crude to copper, from gold to silver, most commodities have been on a tear lately—but is the rise too much, too fast?
So says Dr. Nouriel Roubini, professor of economics at New York University's Stern School of Business and chairman of the RGE Monitor. Best known for his accurate predictions of the current financial crisis back in 2005, Dr. Roubini now argues that the world has set itself up for another bubble in risky assets, like commodities—and when the bubble pops, it won't be pretty.
HAI Associate Editor Lara Crigger caught up with Dr. Roubini at the "Inside Commodities" conference on Nov. 4, where he shared his thoughts on global commodities markets, including why we can't look to China to drive global growth, how $100 oil would tip us back into recession, and what will happen when the commodities bubble finally pops.
Lara Crigger, associate editor, HardAssetsInvestor.com (Crigger): Here we are at the "Inside Commodities" conference—so which commodities do you think will perform well in 2010?
Nouriel Roubini, chairman, RGE Monitor (Roubini): Well, in my view, commodity prices have increased since the beginning of the year too much, too fast, when compared to the improvement in economic fundamentals. Some of that increase is justified. But if the global economy were to have a more anemic, subpar recovery—if instead of a V-shaped recovery, there's going to be a U-shaped recovery—then I actually think demand for commodities would be weak compared to supply, and there could be a correction in commodity prices in 2010.
Take oil prices: They have gone up from $30/barrel to over $80, at a time when demand is back to 2005 levels, and oil inventory is at all-time highs. Part of the increase is justified by fundamentals. But part of it is essentially this wall of liquidity chasing assets, and the effect of carry trade on the U.S. dollar, driving further higher these commodity prices.
So these nonfundamental factors can push oil and commodity prices higher, especially if there's going to be an increase in expected inflation. But the fundamentals of supply and demand actually suggest that, from now on, oil and other commodity prices should be lower, rather than higher.
Crigger: Last year, Jim Rogers spoke at this conference and told us that the U.S. was doomed to be a third-world economy forever. What do you think? Can America regain its competitive edge?
Roubini: In many dimensions, the U.S. does look like an emerging market economy, because it's running significant current account deficits, fiscal deficits and that accumulation of private debt that led to a very severe financial crisis. So now we have to get our act together and tighten our belts, both in private savings and public savings—something we're not doing fully. I'm not bearish on the U.S. economy in the medium/long term, as long as we fix the policy mistakes that led to this financial crisis.
Of course, if you were not to do those things, you could have a decline of the U.S. economy. Certainly, the U.S. economic growth now is only 2.75-3 percent, compared to 6-7 percent in emerging markets. If we don't fix our problems, then the potential growth could be closer to 2 percent eventually, rather than 2.75 percent.
If that were to occur, the U.S. would look like Japan and Europe, where there is economic malaise, slow growth, fiscal problems, high unemployment and large imbalances. That would be something that would lead to the relative decline of the U.S. economy in global economic affairs. But that would be a long-term process, not something that would occur overnight. So no, I don't predict that to happen, but it's conditional on us fixing the mess that we created in our economy. It will take a lot of work by the public and private sector.
Crigger: Speaking of emerging markets, do you think they'll continue to drive economic growth in 2010? Or will the fact that their consumers in developed markets are spending less finally catch up with them?
Roubini: I think they'll fare better than advanced economies, which I expect will have anemic and subpar growth. They're not under the same kind of financial leverage of the houses and the banking system that advanced economies had. And now, they can do countercyclical monitoring of fiscal policy to restore their own growth.
But three caveats I would make. The first caveat: China cannot be the main engine of global growth. China's GDP is $3 trillion; the U.S.' GDP is $15 trillion. The GDP of the U.S., Europe and Japan is $40 trillion. In addition, 300 million Americans consume $10 trillion per year in terms of private consumption, while 1.3 billion Chinese consume only $1 trillion. Even India—900 million Indians consume only $600 billion. The total consumption of 2.2 billion Chindians is $1.6 trillion—only 1/6th that of the U.S. It's just not enough.
Two, the model of growth of China, Asia and most emerging markets has been to spend less than your income, run this trade surplus and sell the excess of production over spending to the U.S. and other deficit countries. But that game is over. Now the U.S. has to spend less, consume less, import less. Therefore, exports have fallen sharply in Asia and so on. So unless they can switch their demand from net export to private domestic demand, recovery of growth will not be to the same very high levels that you had in 2004-2007.
Three, I think part of what China is doing is a mistake, because they're already over capacity. They're pushing up growth on the supply side, rather than the demand side. That's going to increase the glut of capacity in China, in Asia and globally. And it will mean that their growth recovery isn't sustainable.
So I'm bullish about emerging markets, especially Asia and parts of Latin America, over advanced economies. But even emerging markets are going to see constraints to their growth, because of their policy response due to the weaker recovery of advanced economies.
Crigger: There's been a lot of talk recently—particularly from China and Russia—about replacing the dollar as the world's reserve currency. Are the dollar's days as a global reserve currency numbered?
Roubini: Not yet. If the U.S. were to continue to run large, twin fiscal and current account deficits forever and kept on monetizing its fiscal deficits—and there's always that problem of inflation—then there's a chance that the U.S. creditors are essentially going to pull the plug on the U.S. dollar. You could have, as a result, a weakening of the U.S. dollar as a reserve currency.
But usually, the decline of a reserve currency is not something that happens overnight. It's something that occurs over a decade or two decades, and so on.
So the dollar weakness—everything else equal—is a concern, but right now it's not yet disorderly. If there were a collapse, something I don't expect, then yes, you could have a situation where the fall of the U.S. dollar as a reserve currency could accelerate. But it's not the most likely scenario.
Crigger: Switching gears, you've said that gold is only useful as an investment in situations of hyperinflation and catastrophic deflation. But what do you think about other precious metals with industrial applications, such as silver and platinum?
Roubini: Precious metals prices are going to depend on supply conditions compared to demand. There is a global economic recovery, and that implies that demand is rising. But like I said, this isn't totally justified by the fundamentals of supply and demand, but also a wall of liquidity chasing assets, less risk aversion, and this massive "mother of all carry trades" that uses the U.S. dollar as a funding currency.
So in my view, some of the increase—even in precious metals—is not justified by fundamentals. The supply looks excessive, and it looks like part of a bubble, a generalized bubble we see across the world.
Crigger: But does gold still have a role to play in currency, either as a de facto or literal currency standard?
Roubini: Well, the central banks are diversifying their foreign reserves, and that's increasing their demand for gold. China's doing it; India's doing it; others are doing it. Gold is going higher in part because of this central bank diversification, and in part because, of course, whenever the dollar weakens, we see an inverse relation within the dollar price of commodities, including gold.
But if you ask me, can gold can go towards $1,300, $1,400, $1,500 or $2,000, like many gold bugs say? Well, there's only two scenarios in which that could happen. First would be a real increase in global inflation, and we don't see that right now. In most emerging markets and advanced economies there is actual deflation, because there's glut of supply rather than demand, workers have no pricing power and they cut wages. So in a situation where there's deflation rather than inflation, why would gold be staying high? It cannot be. It can go up above or below $1,000, but it's going to move around those levels, and it's not going to break toward $1,500.
The other scenario is Armageddon, another depression, where everybody would buy canned food, guns, ammunition and gold bars and run to a cabin in the mountains. That was the risk after Lehman, but that risk has been severely reduced.
So we don't have Armageddon; we don't have inflation, so gold can maybe go slightly higher. But those people who delude themselves that gold can go to $1,500 or $2,000 are just talking nonsense. The fundamentals are not justified, and those people are just talking their books.
Crigger: Is OPEC still effective at managing oil prices? In the 1970s, they were viewed as this mastermind of pricing; but these days, they seem pretty ineffectual.
Roubini: OPEC can manage prices marginally. The only supplier that has excess capacity that can use it to stabilize oil prices is Saudi Arabia. But once oil is above $80 like it is now, ETF demand, options demand, speculative demand, these can easily push it to above $100.
I would say that if there were a reason we had the global recession last year, it wasn't just Lehman or the subprime mortgage problem; it was that when oil went to $145. That was a major, real trade shock negative, and a real disposable-income shock for the U.S., Europe, Japan, China and all the other oil-importing and commodity-importing nations around the world. That kept the world in recession when oil was at $145. Now, I feel that oil at $100 is going to tip the world into a double-dip recession.
Roubini: Because last year, when oil went to $145, half the world, like emerging markets, was growing very fast. But today, with the global economic collapse, we're now barely out of the ground. The economy is on its knees, trying to rise. If oil were to go because of nonfundamental reasons toward $100, then I would say oil at $100 would be like a big hammer beating on the head of the global economy. At current levels, oil prices aren't justified, but they can go higher because of market dynamics and speculation; much higher.
Crigger: You've come out in favor of position limits for commodities—how would that solve this problem?
Roubini: I'm in favor of position limits, because I think this volatility in oil prices is severely damaging the global economy. When oil goes to $145, we have a global recession. When oil goes to $30, nobody invests in new capacity. And these swings in boom and bust in oil prices are extremely damaging to economic growth. It's time to control it. If we don't control it, these booms and busts are going to become more severe, more damaging and more risky.
Crigger: If we put in place position limits, how would that impact futures-based commodities funds? Would that kill them off, as some have said?
Roubini: It might kill them off, but frankly, who cares? I care about the real economy. I care about not having another global recession. If people are speculating on oil, and that pushes oil up to $145 like last year—I'm in favor of limits on that. Who cares about this? Frankly, I couldn't care less.
Crigger: Thanks for your time. Enjoy the conference!