Commodity Super Cycle - 1/20/08

Hobert Pruitt
Beyond Fossil Fuel Columnist

I have been studying and trading commodities for the last ten years.  Recently I read a book written by Jim Rogers called “Hot commodities”.  Jim made it so completely clear how commodity and equity cycles work.  Jim is a successful commodities trader and has a number of his own commodity funds which have been very successful. 

Commodities are natural resources which are consumed by people everyday.  Commodities include hydrocarbons like oil, unleaded fuel, natural gas as well as wheat, corn, cotton, soybeans, aluminum, copper, silver, gold cattle, hogs, pork bellies, sugar, coffee, coca, rice, wool, rubber, lumber and 80 other things people consume everyday.  Unlike stocks that can go to zero, in value commodities the “real things” cannot go to zero in value.  They are essential to everyone’s life.  Every time you walk into the grocery store or mall you are surrounded by commodities that are traded around the world.  They are traded in futures markets that set and regulate prices.  Without the futures market the “things” we need for life would be scarce and often too expensive. 

The last commodity bear market ended in 1998 with prices approaching 20 year lows, equal to Depression levels when adjusted for inflation.  According to Jim, during a period of a commodity bear market, equities (company stocks) are experiencing a bull market because the “things” they buy and consume to manufacture “things” are cheap making them more profitable. 

During this commodity bear market producers of these things like oil are seeing their profits go down.  During this period, exploration for oil is at a low because it is not profitable to invest in new exploration.  Coffee farmers in South America are not making money on coffee so they tear down their trees and plant something else that hopefully will make a profit.  Farmers stop planting corn when it cost them more money to grown corn than the profit they make. 

In the mean time, commodities are being used everyday non-stop.  Demand for the “things” we use everyday keeps going.  So as producers of commodities slow down their production because they are not turning a profit, supply naturally goes down.  At this point supply and demand factors start kicking in.  As supply goes down and demand goes up prices goes up.  We then begin a long term secular commodities bull market.

Jim’s research finds that during the twentieth century there were three long commodity bull markets where prices went up, (1906-1923, 1933-1953, 1968-1982) each averaging 17 years.  A new commodity bull market has begun in early 1999.  Will this bull market last 17 years, historically it should.  This would mean higher prices for the things we need like unleaded fuel.  Jim believes we will see commodity prices increase till around 2015. 

What does this commodity bull market do to stock (companies that make things)? As their cost to buy and consume things go up their profits go down, creating a bear market for equities or stocks during a bull market in commodities.  This also causes rampant inflation and even major downturns in the economy. 

These increases in cost also affect producers of commodities.  As oil goes up it cost more to farm crops and mine minerals.  With the coming financial crises, credit is tightening up as this article is being written.  Commodity producers wanting to expand to take advantage of this bull market find obtaining capital difficult.  As cost soars expansion and exploration is abandoned because it just doesn’t make sense economically. 

So what does this mean?  It confirms we are in a commodities super cycle.  High capital cost are going to delay a lot of the expansion and exploration,  which would have brought more oil, gold, copper, coffee pretty much every commodity to the market.  This also confirms this commodity bull market has a number of years left in it. 

No major oil field has been discovered in the world for more than 35 years.  Some of the giant multibillion barrel reservoirs are 50 to 70 years old.  U.S. oil production peaked in the early 1970s and has declined ever since.  The world’s largest producer of oil is Saudi Arabia.  They may have reached their peak and soon will be declining.  The U.S. has not built an oil refinery since 1976.  The number of domestic refineries has decreased by half since 1982. 

Natural gas production in North America is not keeping pace with demand and supply, catching up is remote.  Like oil fields around the world the known natural gas deposits are old. Most of the U.S. produces its electricity from natural gas.

Environmental regulations and local restrictions prevent or delay the digging of new wells in many areas. 

Maybe ethanol will save us till this commodity super cycle is over, but think about it, almost all of the bio-fuel produced is from commodities.  60 percent of the world’s ethanol is produced from sugar.  Brazil is the world’s largest producer, using half of its sugar crop to power its cars.  Sugar supplies are diminishing causing higher prices.  For more information on Brazil’s ethanol production go to this link http://www.beyondfossilfuel.com/ethanol/brazil_0513.html

Ethanol made from corn in the U.S. is in the same boat.  Demand for corn has been tremendous causing the price of corn to go up.  Great for the once starving farmers, but what about the consumer trying to keep his family fed.  Ethanol demand, along with price increases has caused increases in food prices.  Learn more about Peak Food.

When adjusted for inflation, prices for commodities really are not all that bad.  After all, bottled water cost more than gasoline.  Crude oil’s record high in the 1970s would be over $90 a barrel in today’s dollars.  Gold’s record high in the 1970s would be over $2000 an ounce.  At the time this article was written, oil is at $89.00 a barrel and gold is at $900 an ounce, leaving room for most commodities to move higher.  Jim tells us in his book that history points out in every bull market everything reaches an all time high.  Factor in war and political chaos, commodity prices could go even higher. 

When you see headlines about the discovery of new oil reserves or wind farms coming on line and casual conversation is about pork bellies and not Google stock, you can expect stockpiles of all kinds of commodities will be rising.  It will be then when the bull market is over.  If Jim is right we may not see this till sometime around 2015.

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