Outlook for Commodities

July 29, 2022No Comments


Hello, and welcome once again to the Smart Money, Dumb Money Show. And I am your host, Keith Richards. I’m the president and chief portfolio manager of ValueTrend Wealth Management. And today we are going to talk about commodities and inflation and all that kind of neat stuff. So I’m taking a broad view of commodities. I am not focusing too much on any one part of the sector except for oil a little bit. So let’s get started. It’s a fairly big presentation and there’s a lot to talk about. So let’s get right into it. And what I’ve done, as I often do with these types of presentations, is I do a presentation on a PowerPoint. So I’m going to just start from the beginning. And so this is a commodity outlook that combines some very big macro picture stuff to some closer views. And I’m going to talk a little bit about why the technicals and fundamentals may indeed be lining up.

So I want to start off by talking about population growth. Now, everybody knows the population in the world is expanding, but one of the things that really is important to understand when it comes to commodities is that the Asian population in particular, and that’s represented by this red line here, and the African population, which is represented by this blue line, are kind of developing emerging nations that are expanding in population. And these folks are the ones that are going to be increasing their load of commodity usage. And that’s because they both use them in their own countries and they manufacture for other countries using these materials. Now it’s interesting to understand that, while we see North American population growth. Sure. It’s increasing, but not by much, but we are already using the materials. We already have, you know, the manufacturing and whatnot. So it’s, as the developing world becomes more used to having a computer and a car and that kind of thing, more percentages of the population increase their general wealth.

 

That means that commodities are going to be not just manufactured there, but used by their population. So it’s really important to understand that this is a whole new market for stuff that is being created by population growth in the more developing nations. And these developing nations are the ones that are growing, but they’re not just growing in population. So it’s really important to understand as well that while North America and Europe are seeing a crunch when it comes to their economy and a problem with inflation, we’re seeing some interesting things happen in Asia and some of the developing nations, particularly India. So I’m gonna go over these, and this is research taken from my good friends over at Bear Traps, Larry McDonald. So he noted that China is mulling doing a 220 billion dollar stimulus package right now. And that, of course, floods an awful lot of money onto their market.

 

And meanwhile, their business activity index is climbing. So our business index activity is actually starting to decline. We’re on the rolling over part of that cycle whereas China has been increasing and India purchase managing index, purchase manager index, has been rising. And in fact, it increased a full point in May, not only in May, but in June we also saw the fastest pace in India in business activity. So again, things are happening in these nations where they’re beginning to enter that wealth effect, where they’re going to be buying and needing more goods and services. So the data is showing some upside in China and India, and these are big population growers and they’re big usage growers. So they’re also fossil fuel users. They’re not equipped for everybody to be buying a Tesla just yet. Now there are, you know, electric cars and whatnot coming out of China, but there’s still a big use of coal, of oil, that kind of thing to power things and, and for automobiles, particularly in India.

 

So they’re using fossil fuels and that’s only going to increase in the next number of years as their population continues to grow. So with this in mind, their stronger economies and growing populations and growing usage means possibly a lower flight to the US dollar from the fear trade that we are in right now. And we’re gonna look at the US dollar in a few minutes. So all of this is bullish for hard assets, things like commodities, and it’s ultimately bearish for the dollar, because if people have more confidence in other markets that they don’t fly into the US dollar for safety. So it’s a bullish case for commodities, especially as, and we’re gonna talk about inflation in a minute, especially as inflation stays relatively high. The keyword being relatively, and we have all this expansion going on in some of the big developing nations with higher population growth than we have here.

So US dollars of course, makes it easier for emerging markets to pay for their commodities too. So it’s just a circle of potentiality for inflation and commodities. So this is a very new forecast from the US Energy Administration Center. And they have their short term energy outlook as of July of this year. So it’s right up to date and their forecast, you can see that the production line, which is blue, production of oil varies up and down and consumption of oil varies up and down. The two meet for a while, but rarely stay together. They jump around, you can see why energy prices were falling in 2020. COVID crash, people stopped using consuming fossil fuels so much, less driving, less manufacturing as places closed down. And of course production decreased with it.

 

But now we’ve been in the opposite situation, which is why oil has gone up in price, not to mention the Ukraine war and whatnot, but you can see the forecast is for them to come together. But I think this is an optimistic forecast because historically we don’t see that kind of balance where, you can see down here, the implied draw downs on their reserves is more or less flat. So consumption in production, they’re saying, will keep up with each other in 2023. I think that’s an optimistic outlook. And so does Larry McDonald of Bear Traps because the factor that may not have been taken into account is that demand for energy in these developing worlds and their population growth. On top of that, when we talk commodities, we’re not just talking about oil, we’re talking about other things, and that includes good old food and nitrates.

 

You’ve seen, no doubt in the news, what’s going on with the farmers, the Dutch farmers, protesting over the crackdown on nitrates. Well, nitrates are really important to increase the crop yields. So you want to produce more crop on same piece of land, you need your nitrates. And that’s one of the ways we’ve been feeding the world population on a ever shrinking footprint of farms is because we use modern farming technology that in includes potash and the like. Well, they’re talking about kiboshing some of the usage of these things for the environment, but again it’ll be, to me, it sounds like the same story that happened in 2021, where they shut down all these pipelines and exploration of energy and look where we are now. Oil prices are more than doubled since then. So same thing, they’re even looking at this in Canada.

 

It just seems that the developing worlds just doesn’t get it. And as this article taken from the EU Times is saying that there will be global food shortages and that could result in civil unrest. So it’s not a good thing to be doing these save the world environmental programs when we’re in the middle of a food crunch. Just the logic of these things just constantly befuddles me. But this is another factor that drives the prices of commodities and food is a commodity, you know, livestock, et cetera. These commodities, it makes sense that these are going to continue to be expensive and go up at the same time we have cheap money. And today is the day of the Fed announcement. I’m talking on the 27th of July and the Fed hasn’t announced yet, but we’re pretty much counting on at least a 75 basis point increase in their Fed Fund Rate.

Now, that’s probably lower than what was previously anticipated. And I think the market might rally for a few days, but that’s not what I’m here to talk about today. What I’m trying to say is that rates as of the 26th of July were less than 2%. Let’s say it’s less than 3%. It’ll be over 2% after the Fed announcement today. We still have very cheap money and you can see that historically on this chart that, you know, really rates are cheap even at 3%, even at 4%. So will increasing rates really bring, bring inflation down to 2% again? Probably not. So let’s take a look here. The Bank of Canada, same thing they’re currently at two and a half percent. So both of the, both sides of the board are gonna have similar overnight rates. Long term inflation in the states has been about 3.2%.

 

And in Canada it’s been 3.12%. Well when the Fed and the Bank of Canada both have talked about bringing inflation down to 2%, that’s kind of a pretty lofty goal, and I’m not an economist, but I think they’re blowing some pretty serious smoke here. And I honestly can’t see how that is going to happen given some of the factors we’ve already talked about such as food shortages, population growth, population usage of some of these consumable products that all drives inflation, and unless they are prepared to drive us into a major, major recession through strong monetary policy, and I don’t think they’re going to tighten that much, then, you know, we’re probably going to be seeing a return, not to 2%, but maybe three or even 4%, which is probably more realistic on slightly higher than the average inflation rate going forward.

Well, what does that mean? Well, again, all of these factors suggest that the US dollar, which has been the place to go, may be peaking. You can see going back to 2003 we’re right at those old highs. And we could see a decline from these levels if as and when you know inflation continues to pick up and other economies start to outperform North America to some extent, or at least get some of the economic attention of the world through their production. So let’s let’s look at where commodities themselves stand, because what do you do in a weak US dollar, in a rising inflation environment and an increased demand for materials from the emerging markets with their higher population growth, you want to buy commodities. And so people think, well, we’ve had this big rally in commodities, true enough, but this is the CRB index.

 

You can see the big rally. It broke out of, we were buying back here, Craig and I back in 2021. We get to take our hats off there. We have seen the rally. We’re seeing a pullback now to an old support level. My belief is that if we do see some more pullback on commodities, it won’t be that extensive. And there’s an argument to be made that we could see about a 30% upside still to come minimum on the commodities index. And that’s just assuming we hit old resistance points going back to say 2010, 2006 or so. Now I could present an argument for an even bigger picture. And this is a chart that I have shown before. Now this is courtesy of, and I’m gaping on who provided it, so I will provide that in an upcoming research paper cause I’m going to reprint this chart, but they’re showing the same thing that I have shown before, which is if we go way back to 1800 and look at commodity cycles, there is a rhythm to it.

And, you know, right on schedule with the COVID crash, we saw a bottoming in the pricing, and you just saw that on the CRB chart. We go back, there’s the COVID crash CRB chart, all time lows, or very, very, very low point. And the prediction was, correctly, for the Commodity Research Bureau Index to start rising. It has, and the prediction might be for it to rise quite substantially over the next 20 years or so, according to this chart. So there’s lots of arguments technically that could be made towards a longer term view on commodities. But even if we want to concentrate on what’s happening right now, I’ll just summarize what we’ve talked about today. That is that if the bank overnight rates, the Fed Fund Rates remain even at 4%. So they’re, they’re less than three right now, but they could go up another percent and a half or so that, and get around 4% that still would not drive inflation from the current 9% down to 2%. You might get it down to 4%.

 

So absolutely inflation is going to fall in the next six months, 12 months, whatever it is, but are we going to see 2% again? I really can’t see that because monetary policy is still pretty easy. You saw that chart of long term interest rates. It’s, they have been at 4%. That’s pretty low. A weaker dollar would increase inflation because you can, you know, cheap buy stuff in the US cheaper. So there’s a lot of talk about inflation or sorry, a recession. And I have talked about it. My own view is that we will have one, but it could be kind of a stagflation inflation. So what that means is the economy remains relatively stagnant even though we have higher level of inflation or maybe 5% inflation then had been the case over the past number of years. So again, inflation will come down, but not down to 2%.

 

So that could still be considered a relatively inflationary environment. And that could end up in combination with the softer economy. That’s called stagflation. The other thing is that the war in the Ukraine is not over and that of course creates need for the grains and the oil and all these factors that were coming out of the Ukraine and Russia that are not coming out anymore. That will end eventually, but it doesn’t seem to be ending right now. So there’s still some pressure there. Our current oil supplies are relatively low and you saw that the gap between usage and production. Now the prediction by the US Energy Board is for them to come together to balance. But they really are not leaving themselves a lot of room for error. You saw the line at the bottom of that chart that showed us how tight the difference between supply and demand is and will be. And yet we have China, which has yet to really emerge and start spending again and India, which is definitely showing massive increases in business production. And you saw that on the statistics earlier, they will be hungry for raw materials. And of course the world population growth ultimately needs more need for commodities, especially in those zones like India, China, and other emerging markets.

 

So there’s some real food for thought here, as far as the long term outlook, or at least midterm outlook for commodities. And I hope it’s given you some food for thought. Now I’ll finish up by noting that in the last video, I noted that we’re doing a big research project on the macro cycles on the market. We pretty much just wrapped it up today. Today is July 27th. I’ve got to go over it, insert charts and do a few other things, but I’m hoping to have that out in the next week or so. If you are a subscriber to the ValueTrend Newsletter, the email updates, you will get a copy of this very comprehensive newsletter and I think it’ll be very enlightening. If you’re not a subscriber, go online and hit the subscribe to our newsletter button. I think it says always be informed and you click there and you can subscribe and we’ll get that out to you when it’s produced. Thanks for watching. And we’ll see you next time.

 

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