When talking about commodity futures, it is very easy for people
to associate it with risks. Yes, commodity futures trading involves greater
risks than buying stocks. However, we would like to inform you that we will
experience a commodities bull market in the next decade or so.
Here are the reasons:
20-Year Low Commodity Prices
One positive for commodity prices is the 20-year low in commodity prices. The
last 20 years have been a bear market for commodities. Formerly the biggest
commodity brokerage company Merrill Lynch closed down its commodities trading
department because of lack of interest from the general public in trading
However, commodity prices follow a 35 to 40 year cycle, which
leads to 17.5 to 20 year upward trend and 17.5 to 20 year down trend. In fact,
some commodities have already seen their prices go up in the last a few years or
months, namely cocoa, crude oil, etc.
All these signs are signs of extreme pessimism in commodities
would be signs of extreme optimism for contratrians
Demand from Asia for Commodities
Another positive for commodity prices is demand from Asia. The 1997 depression
in Asia led to very weak demand for commodities; however, as Asia’s economies
rise back, there will naturally be a strong rise in demand for all types of
commodities as the region's economy grows.
There is also a strong correlation between the performance of emerging markets
and the performance of commodity prices.
Demand from China
Another driver for commodity prices is China. China is one of the few countries
in the world today with a steady, long-term high-growth rate. As Marc Faber
mentions in his book “Tomorrow’s Gold” that “China will become the top consumer
of Asian natural resources, send out Asia’s largest number of tourists, and
invest heavily around the region in joint ventures or take over entire
businesses.” Therefore, China’s demand for commodities is expected to escalate
during the coming years. Marc Faber concludes on China: “In fact, I regard the
purchase of a basket of commodities as the safest way to play the emergence of
China as the world’s dominant economic power.”
According to our private investigations, China has already seen
a shortage of some of the main commodities, namely steel, timber, oil, and
others. The continued growth of China's economy and the need for raw material
supplies would definitely continue the trend, not reversing it.
US Dollar Depreciation
US Dollar depreciation is another factor for the rise of commodity prices.
US dollar is currently depreciating against all major currencies. The trend is
continuing and will be continued. (Yes, the United States is the largest debtor
nation in the world.)
With US dollar depreciating against other currencies, you can
hedge yourself by buying currencies such as the Euro, Japanese Yen, British
Sterling, Australian and New Zealand Dollar or Canadian Dollar. Or better yet,
you might want to hedge against a basket of commodities. This would mean
commodity price increases as the US Dollar value decreases.
Deflation or Inflation
Commodity prices in the coming years will be influenced by two the forces of
deflation and inflation. If deflationary forces dominate, commodity prices will
tend to decrease; if inflationary forces dominate, commodity prices will tend to
increase. However, this is not always and necessarily the case.
There has been much discussion recently about whether the United States is
heading for generally much higher inflation or a deflationary depression; in
either case, commodity prices have a tendency to rise.
During the last twenty years or so as mentioned above, commodity prices have
essentially been in a long bear market with declining inflation rates. This
decline in inflation has even now gone to the point of a general fear of
impending deflation. This is especially true when consideration of the massive
export potential of China to produce manufactured goods at significantly lower
cost than the Western industrialized countries. However, the loose monetary
policies of the Western industrialized countries could lead to much greater and
even severe levels of inflation in the near future. This in turn could raise
commodity prices significantly likewise.
In the case of inflation, it is easier to understand; however in the case of
deflation, it may appear to not make sense. But in the Great Depression,
commodity prices doubled from a low in 1932 to a high in 1934. If the decline in
the demand of commodities in a deflationary recession is met with a larger
decline in the supply of commodities, commodity prices may then likely increase.
This is essentially the case now in the global economy; last year, commodity
prices increased by more than 20% in this regard.
The current situation is somewhat like the beginning of the stagflation of the
1970s – with inflation in some areas and deflation in other areas. In
particular, it appears as if inflation is appearing now in areas involving
resources and deflation is appearing in areas involving mostly Asian exports of
low-cost manufactured goods, clothing, and household items. There is much
discussion as to whether deflation may also extend to the real estate sector.
Inflation in areas involving resources means rising commodity prices.
US Federal Reserve Board Policies
Some significant conditions for rising commodity prices are the loose monetary
and fiscal policies of the US Federal Reserve Board.
Excessive monetary stimulus and rapid credit expansion will always eventually
lead into hard asset markets such as real estate, commodities, and precious
metals, which then, in turn, lead to higher inflation rates.
The Federal Reserve Board recently published an essay entitled “Preventing
Deflation; Lessons from Japan’s Experience in the 1990s” (International
Discussion Paper, Number 729, June 2002). In this essay, the Federal Reserve
Board mentions “that when inflation and interest rates have fallen close to
zero, and the risk of deflation is high, stimulus – both monetary and fiscal –
should go beyond the levels conventionally implied by baseline forecasts of
future inflation and economic activity.” The effect of these loose monetary and
fiscal policies have the overall effect of US Dollar depreciation, leading to
the situation described above under the section entitled “US Dollar
Furthermore, following a January 2002 meeting of the Federal Open Market
Committee (FOMC), a Federal Reserve Board mentioned that in the extreme event
that its loose monetary and fiscal policies become ineffective, it would take
“unconventional measures” such as the “buying of US equities” or any “state or
local debt, real estate and gold mines – any asset”.
And more recently, the next potential likely incumbent of the Federal Reserve
Board Chairman after Alan Greenspan, Ben Bernanke, mentioned his now famous
statement about the government having a technology called the printing press to
which it can use in fighting deflation.
All of these Federal Reserve Board policies are setting an environment that will
be very conducive for a depreciating US Dollar currency and ensuing rising
Rising Government Budget Deficits
Rising government budget deficits, at both the federal and state levels, will
add significant pressure to a depreciating dollar, in turn providing another
factor for rising commodity prices.
A very positive factor for commodities is the energy situation. The current
longer-term relatively higher energy prices, such as oil, are creating a
situation similar to the energy crises of the 1970s.
There have been numerous recent studies which indicate that current oil and gas
fields have peaked in their maximum levels of production, that the easy-to-get
oil and gas reserves are being depleted, and that future potential reserves will
be much more expensive to mine and extract. And not to mention the growing
demands and usage of energy by the developing world - especially from such
countries as China, Vietnam, and India. Recently, China battled against (and
lost) Japan to gain a oil pipe line from Russia.
All of these factors point towards much higher oil and gas prices, translating
to much higher commodity prices in general. It is to be noted that many of the
other commodities, such as soft agricultural commodities, are either derived
from or produced with oil and gas products.
Recession or Recovery
Another point worth noting is that commodity prices will increase significantly
in the periods immediately after the end of a recession; this is because after
recessions, demand for commodities generally picks up considerably.
As the global economy expands, the demand for commodities will correspondingly
rise and with it, commodity prices. An economic recovery will generally demand a
higher usage of commodities, resulting in higher commodity prices.
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