Are We Currently in the Middle of a Commodities Super Cycle?

"Commodities get no respect" are the words that investment guru and Quantum Fund Co-founder Jim Rogers uses to begin his recently updated edition of Hot Commodities. With nickel and corn hitting record highs during the past few weeks -- and the Rogers International Commodity Index [RICI] up almost 20% just this year -- commodities are back in the headlines.

Over the past 10 years, Rogers has become the best known advocate of the "Commodities Super Cycle" theory. According to Rogers, the 20th century has seen three secular bull markets in commodities (1906-1923, 1933-1955, 1968-1982). Each of those secular bull markets has lasted a little more than 17 years. Rogers believes that we are currently smack dab in the middle of yet another secular bull market in commodities that began in 1999.

Relishing his role as contrarian gadfly, Rogers began flogging commodities to a skeptical audience on CNBC in 1998, while the rest of the world was entranced by JDS Uniphase, Enron and Pets.com. Merrill Lynch had just exited the commodities business, and commodities prices were approaching levels that hadn't been seen since the Great Depression. Unhappy with the make-up of the Dow Jones, Reuters and Goldman Sachs commodities indices, Rogers set up RICI in 1998 to become his own index and fund. Rogers' index consists of a diversified portfolio of 36 commodities, including soft commodities such as wheat and corn, hard metals like nickel and copper, animals such as live cattle and lean hogs, and a dash of canola and azuki beans.

Just how right has Rogers been? The Rogers International Commodity Index was up 249.7% through March 2007. By way of comparison, The Lehman Brothers Long Treasury Index was up 72.8% over the same period, with the S&P 500 trailing at 45.4%.

And in a move that surely brought a smile to Rogers' face, Merrill Lynch in 2005 launched a product on the Chicago Mercantile Exchange (CME) that tracked the performance of the RICI.

The Commodities Super Cycle: An Image Problem

Say "invest in technology" and people hear "potential Google billionaire." Say "invest in commodities" and people hear "risky" -- then tell you about a brother-in-law who lost his shirt getting caught on the wrong side of soybeans. Yet many more brothers-in-law lost their shirts in the dotcom bust than have ever lost them in commodities.

And surprisingly, most commodities have been less volatile than technology stocks. This is born out by recent academic research at Yale. Since 1959, commodities futures have produced better annual returns than stocks and bonds -- with less risk. The volatility of commodities futures was actually below that of the S&P over the same period. Another plus? Commodities have had a remarkably low correlation with the stock market by zigging while stocks have zagged. Commodities prices also tend to go up during times of war and political chaos. And unlike Enron or Worldcom, commodities prices can never go to zero.

The Commodities Super Cycle: The Bull Case

The last Commodities Super Cycle bottomed around 1998 when years of low prices had depleted commodities inventories across the board, just as demand was accelerating for commodities across the globe. Americans needed oil to feed gas guzzling SUVs. New McMansions gobbled up huge supplies of lumber, steel, aluminum, platinum, palladium and lead. And Europeans began to mimic American lifestyles, as well. In Asia, both Japan and Korea became world leaders in importing commodities.

The real action, however, was in China. Over the past decade, China had become the #1 consumer of copper, steel and iron ore in the world by consuming more of both than the United States and Japan combined, as well as by ranking as the #2 consumer of oil and energy products. And China's population of 1.3 billion ensured its insatiable appetite for soft commodities as well, as it became the world's #1 consumer of soybeans.

Meanwhile, the supply side also was pressuring prices. No major oil field has been discovered in the world for the last 35 years. Virtually no new mine shafts have been opened in the last 20 years. And new sugar plantations were as rare as black swans -- despite 60% of the world's ethanol being produced by sugar.

The Commodities Super Cycle: Is the Party Over?

Over the past 10 years, commodities have been a terrific place to be. Yet despite its recent jump, the RICI is down since the start of 2006. Indeed, diversified commodity stocks like BHP Billiton and Rio Tinto have been locked in a trading range for the past year. An obvious question arises: Is the party over? Rogers answers with an emphatic, "no." Rogers expects the commodities bull market to last until at least 2015.

But to be fair, comparing the returns of commodities to the S&P 500 during the past ten years is unusually favorable to commodities. Even then, annualize the 249.7% return in the Rogers commodity index since 1998 and you find that it returned around 11% per year. That's just about the same as, say, what a well-run and diversified university endowment produced over the same period.

And dotcom bust notwithstanding, many global stock markets outperformed Rogers' commodity index over the past 10 years. Particularly irksome for Rogers must be the performance of the Russian equity market -- a country he famously despises. Yet the numbers don't lie. Had you put your money into Russia at the same time Rogers launched his index, you'd have just about 10x the money that you'd have made by investing in Rogers' Commodity Fund. And investors like Bill Browder, of Hermitage Capital Management, actually have done just that.

The bottom line? Rogers has been spectacularly right on the Commodities Super Cycle. And that's why Rogers -- the hedgehog who knew one big thing -- will have made 10x the money he would have received by betting solely on the S&P 500. And for that achievement alone he deserves kudos. As Rogers likes to say, no one can repeal the law of supply and demand.