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Long termed blog reader, Daddyo, asked me to cover the commodities cycle on a blog. I thought that would be a great topic.
Lets start off with the big picture. Below is the 20 year CSCI commodity index chart. Note that it showed rising commodity prices to 2008, then a new downtrend. Note that the trendline has been hit regularly within that downtrend. Note that the index is coming into old support, which will create some level of technical resistance. However, the probability is for a test of the down trendline. That might allow the index to get near its old resistance point near 2700, which is about 24% higher than todays levels. What would a commodity bull market look like? If the downtrend is broken and 2700-ish is taken out on the GSCI index, I would think that might be the look of a new bull market. It would meet my rules of a higher high, and a trendline break. See my book Sideways for more on that.
One influence that would drive it to those levels (or break the major downtrend line) would be inflation. So, lets look at that next.
US Bureau of statistics posts their CPI figures regularly. Here is the 20 year chart with my notations drawn on it. Note that CPI rose with the commodity index to 2008. Note that CPI made lower peaks in a declining trendline since that 2008 high. Note that CPI is coming into the same support point that the commodity index is visiting. If CPI rises later this year, that would bring it to the similar trendline as is illustrated on the commodity index. If the trendline is broken, that would be as significant as a breakout on the commodity index.
Clearly, commodity prices have something to do with inflation. If inflation picks up as the economy rights itself in the post-COVID era, there will be lots of money floating about with an eager consumer and corporate spender to help drive inflation. That’s one argument for a rising commodity price.
Daddyo asked me what commodities I think might be affected, should the above potential come to fruition. . My answer: All of them! Gold and silver are classic inflation hedges – silver having industrial applications to boot. Copper is the classic industrial metals leader. Potash and agricultures would become more expensive as demand for all goods rises.
Now..what about energy…specifically, oil and nat. gas? This is an area (in my opinion) that offers one of the higher upside potentials. Most of the commodities just listed have rallied. But oil and gas are still a bit suppressed. I wrote about Nat. Gas last week. That’s because we’ve bought into the ESG and New Green Deal mantra. The contrarian in me is screaming!
Sentiementrader noted in a December update that energy’s poor performance isn’t a bad thing at all: “When we look at long-term returns after the ends of such long streaks, there were further gains every time during the next 1-2 years. It was volatile, but the sector enjoyed an average gain of more than 42% at its best point during the next 2 years.”
Green movement has less impact on carbon energy production than you might think
I read this absolutely brilliant commentary from Larry McDonald in his Beartraps report on the reality behind the Green Movement, and the outlook for energy. Like it or not, carbon energy ain’t going away soon. I highly recommend you read the following very carefully:
“….altruism doesn’t work and future threats of disaster don’t work. Only a clear and present catastrophe works. Now, the 25 people of China’s Politburo control the lives of the 1.44 billion China citizenry. What do these 25 people care about? Ethics? Selfless sacrifice for the greater good of the planet? Noble disregard of personal interest for the benefit of all humanity? Uh. No. They care about one thing and one thing only: power. Therefore they fear one thing and one thing only: loss of power.
To solve global warming, taxes and rules have to be put in place to make it more expensive to emit carbon. That in turn makes fossil fuel use more expensive. That in turn means Chinese consumers will have less money to spend. That in turn means their standard of living goes down. That in turn increases the odds of an overthrow of the Politburo. We are largely immune from being aware of China’s internal dissent, but there are multiple riots every single day in China against local corruption. Revolutionary fervor is hardly absent from the Hunan hinterlands that produced a Mao. And the Politburo knows it. So, the calculation is straightforward: once environmental catastrophe is of more concern to the people than living standards, once environmental catastrophe actually directly lowers China’s living standards, then, and only then, will China join the US in putting a price on carbon by taxing it and rule restricting its emission. Otherwise, not happening. Ever. And if China won’t, India won’t either. Their view is that the West grew and polluted, so its only fair the East grows and pollutes.
…The infrastructure build will push up commodity demand which will cause commodity inflation which in turn will stoke inflation generally. Furthermore, given that globally the average IG (investment grade) bond yields less than 2%, the desire to hedge against the prospect of 2% or greater inflation will increase over time. And the best way to hedge against infrastructure inflation is with infrastructure commodities: metals and oil, both of which, ironically enough, cause carbon emissions to produce and use. We have here, then, a self-reinforcing metals and oil grand super-cycle bull market, a paradigm shift from the past decade of commodity lethargy. “
Conclusion
Nothing within investing is a smooth ride. There will be volatility. But, to answer Daddyo’s final question, what types of investments might we consider in commodity plays. My thoughts are to look at the producers. I have learned that its pretty hard to play commodities unless you get into the actual futures markets. As an equity investor, the alternative is commodity ETF’s. But they don’t track the underlying commodities for most of the smaller moves. So I am more a fan of the producer stocks. Broad ETF’s in the base metals, precious metals, energy and other sectors will suffice. Agriculture ETF’s exist as well. Or, pick stocks. I have some of both.
Hope that helps!
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