Commodities have been popular with investors for many years. But it may be time for caution, suggests Tony Boeckh in his book, The Great Reflation (see book review). Bull markets always face “a huge headwind.” Large price increases do not lead to rising prices over the long term, he warns.
His main points:
Studies show real prices for commodities decline over the long run; "over the past 210 years, industrial commodities, adjusted for inflation, have fallen about 70%.”
Supply rises in response to higher prices over time; “high prices for many commodities have prevailed for almost a decade, enough time for new investment to start increasing supply, particularly as interest rates are low.”
Technology improves the productivity of mining and harvesting methods, reducing production unit costs over time; “for example, shale gas technology has vastly expanded natural gas supplies and knocked the price down over 50% from the peak a few years ago.”
When prices rise for a commodity, demand shifts to lower priced substitutes and technology creates substitutes; “new technologies in wind, solar, batteries and conservation will, in time, reduce demand for oil in developed countries.”
Higher commodity prices can dampen economy activity and undermine demand; “a large relative price increase always [knocks] the underpinnings from the economy.”
The debt supercycle (secular rise in debt) entails no general inflation for a few year at least; “commodities are no hedge against deflation.”
The Bannister and Forward study showing an 18-year rising cycle is flawed; “a more useful interpretation of what is pretty shaky cyclical evidence is that commodity bull markets last about 10 to 11 years.”
Former hedge fund manager Jim Rogers has been a prominent bull on commodities but he also recommends looking for investment opportunities away from popular investing themes; “as Jim Rogers himself pointed out, he likes to be away from the herd.”
Boeckh’s caution would also seem to be a yellow light for currencies and stocks markets that are dependent on commodity prices, notably Australia and Canada.
Disclosure: No positions in commodities or commodity stocks.