Back to Basics

Puru Saxena believes that the current bull-market in commodities and natural resources is still in its early days. Whether you look at food, water, energy or metals; the same story appears. Supply is failing to keep up with rising demand.

I have been buying natural resources since 2001. Back then, commodity prices were the cheapest ever in the history of capitalism and tangibles were not on the radar screen of many investors (they still are not). Fast forward to early 2008, where prices of resources are heading to the heavens, money is starting to pour into the sector and investors are beginning to take notice of the boom. So, where do we go from here? It is my observation that the current bull-market is still in its early days and fundamentals indicate that we have a long way to go. Whether you look at food, water, energy or metals; the same story appears. Supply is failing to keep up with rising demand.

Food – Back in the summer of 2005, I recommended agriculture as a great opportunity. Since then, prices have risen but now we are beginning to see signs that agriculture production may have also peaked (Peak Food). There is mounting evidence that food production peaked in the 1990’s in several world regions. For example, South Asia has lost roughly 50% of its arable land due to soil degradation and China has seen a 27% irreversible loss of farmland. The Asian giant continues to lose roughly 2,500 square kilometers of arable land every year due to environmental issues and urbanization!

According to the UN’s Food and Agriculture Organization, currently 36 countries face food crisis and millions are at risk of starvation. As food becomes scarce, nations are scrambling to ensure supplies and they are trying their best to protect their populations from rising prices. Traditional food exporters such as Argentina, Russia, China, India, Egypt, Vietnam and Kazakhstan have imposed export limits or introduced heavy export taxes in order to prevent domestic inflation and social unrest. Already, we have seen riots over food in Mexico (Tortilla crisis), China, Indonesia, Haiti and the Philippines. If my assessment is correct, I suspect this is simply an appetizer with the main course to follow in the months ahead.

One of the reasons why food prices are rising is due to the changing diet in China. Today, the average Chinese eats a lot more meat and raising cattle is a lot more water intensive than growing grains (Figure 1). So, as more water is used up by the livestock industry, there is less available for agriculture production.

Figure 1: Goodbye, cheap food!


Source: FAO

Those of you who feel that food output will be increased easily should take note of the fact that agriculture is amongst the world’s greatest consumers of water, which is facing its own crisis. A fascinating recent report observes that worldwide, 70% of water is consumed by agriculture. Below I present some of the highlights from this study:

(i) It requires roughly 1,000 litres of water to produce one kilogram of bread. It takes roughly 260 m3 of water to feed one vegetarian person for a year. The more meat in a person’s diet, the higher the water usage.

(ii) Arable farmland is shrinking and as a result, per-capita cropland available has dropped from 0.45 to 0.25 hectares in the past 40 years.

(iii) In order to increase crop yields, farmers have been using more fertilizers, pesticides and genetically modified seeds (wonderful).

(iv)Water shortages are becoming a serious problem for increasing food output throughout the world as widespread urbanization is competing for the same water.

(v) Supply of water is declining as the once mighty rivers now carry only a fraction of their former water volume and the groundwater table is steadily falling. Eleven countries accommodating almost half the world’s population currently have a negative groundwater balance.

So, you can see how water shortages are not helping our cause and may prevent us from increasing food output in a significant manner. Also, not helping us at all is the crazy “let’s burn food to produce fuel” policy being adopted in the West. Figure 2 highlights how rapidly U.S. ethanol production has surged in the past decade and worryingly, it is only going to rise in the years ahead. In my opinion, this policy of burning energy-inefficient corn to produce fuel is a disaster and will cause serious problems in the future.

Figure 2: Washington causing food crisis!


Source: FAO

Whichever way you look at it, food prices are going to stay high for years to come. And any weather disruptions will only add to the problems by causing price spikes to unbelievable levels. From an investment perspective, I suggest that you consider allocating a portion of your funds to companies involved in agribusiness (seed, fertilizer, specialty chemicals and farm equipment manufacturers). Although, they have risen a lot in the past 2 years, I suspect they will continue to produce stellar returns in the future.

Metals – A few months ago, most analysts and investors prematurely called the end of the copper bull-market. According to these folks, such high prices were unsustainable and the copper “bubble” had popped! You may remember that I disagreed with this view and maintained my position regarding a multi-year primary bull-market for all types of commodities. Furthermore, towards the end of last year, I even highlighted copper as a great buying opportunity. Since then, the price of copper has risen significantly.

Furthermore, it seems to me as though copper is currently consolidating prior to launching higher. In case you are confused as to how copper can rise given the nasty housing recession in the United States, you should take into account the fact that China uses up roughly 30% of the world’s copper and its economy is expanding at roughly 10% per annum. In other words, physical demand for the metal is robust in Asia and other parts of the developing world.

It is forecast that global copper demand will continue to rise by 4% per annum over the coming decade. This implies that the industry will have to deliver an additional 1.4 billion pounds of copper every year. This is equivalent to four big new mines every year for the next 10 years. Plus, another four new mines will be required every year over the coming decade just to replace depleted mines. I don’t know about you, but at least in my eyes, this seems like a gigantic, if not impossible, task.

On the supply side, Chile is the biggest producer of copper and its power situation does not look promising. It is likely that similar to South Africa, Chile will see power shortages this year. Roughly 40% of Chilean power is hydro and 60% is thermal (mainly from natural gas supplied by Argentina). Chilean power demand is rising by roughly 5% per annum and with a reduction in hydro-electricity this year due to less rain, thermal power generation would have to rise by roughly 20% to meet demand. This seems unlikely and a power crisis in Chile seems to be on the cards. Should it occur, Chilean copper output will be affected as the operating mines receive less than adequate power supplies. Since Chile is the key player in copper, this is a very bullish development especially with the metal trading close to its all-time high. If you have not done so already, now is a good time to invest in diversified miners with exposure to copper.

Over in the precious metals department, both gold and silver continue to correct within their ongoing primary bull-markets. Having booked our profits a few weeks ago, currently we have no exposure to this sector in our managed accounts. Should prices correct in the summer, we will re-invest in precious metals mining companies.


Puru Saxena
for The Daily Reckoning
June 19, 2008

Puru Saxena publishes Money Matters, a monthly economic report, which highlights extraordinary investment opportunities in all major markets. In addition to the monthly report, subscribers also receive “Weekly Updates” covering the recent market action.

Puru Saxena is the founder of Puru Saxena Limited, his Hong Kong based firm which manages investment portfolios for individuals and corporate clients. He is a highly showcased investment manager and a regular guest on CNN, BBC World, CNBC, Bloomberg, NDTV and various radio programs.

Today, we turn to our war correspondents for dispatches from the front lines, and we find an important insight:

“Learn to live with inflation,” begins the headline in the Financial Times.

The FT refers to England’s central banker, Mervyn King, who says inflation – already running hotter than at any time in 10 years – is going to heat up even more.

In America, the news is not so different. “Globalized Inflation,” is a headline in the Wall Street Journal, finally catching on. Input prices are running up at nearly twice the rate of the official CPI figure. Prices for goods imported from overseas are rising nearly four times as fast.

In Argentina, meanwhile, the inflation rate is officially more than 8%…unofficially, it is probably twice that high.

And across the Rio Plata, Horacio Pozzo reports on “Brazil and Inflation: the struggle continues.” Inflation in Brazil has just registered its biggest monthly gain in 12 years.

It looks like inflation is winning, in other words.

It looks like Ben Bernanke may be “regretting” his rate cuts, says former UK chancellor, under Maggie Thatcher, Nigel Lawson. Bernanke panicked in the face of the credit crunch and cut the key rate from 3.25% down to 2%. Deflation was the greater enemy, he believed. The Europeans saw it differently. The ECB held its rate at 4%…and now says it may raise them. It’s beginning to look like the Europeans were right.

On every front the news is the same – prices are rising more steeply than they were a year ago. Oil rose to $136 yesterday. Gold, sniffing the fear of rising consumer prices, rose $6 to $893.

Oil has been leading the charge for inflation. And T. Boone Pickens says it not only has the high ground…it’ll go higher. He says global oil production has peaked out at 85 million barrels/day while demand is running about 86.4 million barrels. The price will rise more, he believes, until demand for oil falls to equal the available production.

Of course, Pickens is “talking his book.” He’s heavily invested in oil and may want you to be too. But he could be right.

Inflation is gaining ground. Defensive positions are giving way…the forces of price stability (to say nothing of deflation) seem to be falling back. So far, the retreat is mostly orderly. But orderly retreats are hard to pull off. The retreating general is no longer master of the field. He takes what he can get. And what he gets, often, is a rout – when his troops panic. That’s when the casualties really mount up.

We are talking here of a different kind of war. It is a weird conflict…with some remarkable features. For one thing, even though inflation is clearly winning…the U.S. Fed is still fighting deflation, not inflation. The Fed’s key lending rate – at 2% – is barely half the official U.S. consumer price inflation level, last reported at 4.2%. But that 4.2% requires a torture chamber of number crunchers who twist and stretch every figure. “Seasonal adjustments,” they call them. “Hedonic pricing,” they add. As to the former, the seasons never seem to change. Bad raw numbers always seem to get better. As to the second, it is more a matter for metaphysicians than for economists. A computer may cost $1,000 one year. Next year, the statisticians may put the price down to $500 – even though a customer would still have to pay $1,000 in the retail shops. Why? Because ‘it’s a better computer,’ say the water-boarders. If they think it is twice as good, they imagine that the price has been cut in half.

We are not here to quarrel with the thumb-breakers. We are here at The Daily Reckoning headquarters for enlightenment. We read the news headlines. We study the figures. We pore over the opinions, ideas, crackpot theories, and hare-brained formulas. We get down on our knees too…and spend hours in drunken meditation, calling on the gods for inspiration…or luck.

And where does it get us?

We’re never quite sure.

“Discovering…discovering…we will never cease discovering…
and the end of all our discovering will be
to return to the place where we began
and to know it for the first time.”
-T.S. Eliot

Back to the war:

The problem with this conflict is that it ranges over too broad a territory. A monetary policy that might be suited for one area is completely wrong for another. As the WSJ noticed, inflation is globalized now.

But USA Today finally noticed something too. “How rising home values and easy credit put your finances at risk,” was a headline in yesterday’s paper. The trouble was – Americans were given too much credit. Now, their backs ache and their legs buckle under the burden of it. True to his claptrap economic theories, Ben Bernanke is trying to fight a downturn in the only way he knows how – by giving them more. Not only that, but as we pointed out yesterday, they’ve built a life for themselves that is at odds with modern economic reality. T. Boone Pickens may be right and he may be wrong. But even if he’s wrong, he’s probably not too wrong. The days of cheap oil are over. And the days of living in big houses far from job centers, and driving big cars to get work, are probably numbered too. The best thing Americans could do is to adapt to the new situation, as quickly as possible. Which is what they’re doing. They’re driving fewer miles. Many are taking a “stay-cation” this summer, where they leave the family car parked in the driveway. And Ford had to put the brakes on an SUV plant, closing it down for nine weeks because of weak sales.

Bernanke is fighting the last war, not this one. He should have asked us first. You can’t reflate a bubble. You can only blow up another bubble. Bubble money moves fast…from one opportunity to the next. It doesn’t have any loyalty. It carries no passport. It says no pledge of allegiance and wears no flag on its lapel – not in today’s world. So, when the Bank of Ben Bernanke fights a slump, with more and more credit, what happens? The money gets on a plane and goes into the NEXT bubble, not the last. And the next bubble is not in U.S. assets. It’s in commodities, food, fuel…art…and gold.

It is also in emerging markets.

Ah yes, dear reader, the globalization street goes both ways. For 15 years, emerging markets helped hold down prices in the developed world. But now, the American consumer looks for the next truckload of cheap imports from Asia, and gets run over by a tanker truck carrying $4-a-gallon gasoline.

The Fed puts out more money and credit…which is spent on oil and other imports. The money ends up stimulating, not the economy of the United States of America, but the economies of the exporters. The Fed, in other words, is providing a monetary policy for China…for Russia…and for the Gulf States. Unfortunately, it’s the very policy they don’t need.


Because their economies are already burning white hot. Prices are rising fast. Emerging markets, at purchasing power parity, are now providing 70% of the world’s growth. No wonder they’re gobbling up the planet’s resources. And they’re piling up profits. They need to cool off…not heat up. When the dollars arrive in, say, China, the Chinese have to buy them up – creating more of their own currencies to buy them with. They end up with enormous piles of foreign currencies – mostly dollars. A chart of foreign exchange reserves shows them more than tripling since 2001.

While the U.S. lowers reserve requirements to try to heat up its own economy, China raises them. The yuan has gone up 11% against the dollar this year; still, the economy is growing at a breakneck speed. Other nations face similar problems – inflation, out-of-control speculation, and growth. They are raising rates and talking about breaking the link with the dollar – letting their currencies rise to offset the flood of greenbacks and dampen demand for their own exports.

Meanwhile, the Bernanke monetary policy turns out to be just the wrong thing for the U.S.A. too. The Fed pumps out a flood of liquidity…but that money no longer raises up the US economy and US asset prices. Instead, it raises prices all over the world. And now, thanks to globalized markets, U.S. consumers must pay world prices for their corn…and their cars…and their oil…and everything else. And those prices are going up.

Nominal commodity prices are nearing a 35- year high. The oil price has already reached an all-time high in both nominal and real terms. Inflation forecasts have practically doubled for the entire world – just in the last 12 months.

Thus is the weird world getting weirder. America faces a slump…with prices still going up. It is like the stagflation of the ’70s…but worse. Back then, Americans had only a third the debt they have now…and back then, the Fed could still bring inflation to heel, by raising rates and suppressing U.S. demand. Now, even if the fellow next door stops using so much oil, there are 20 fellows on the other side of the globe who will still use more. Could it stop inflation now? We don’t know, but our bet is that there will be a lot of casualties before we find out.

With so many moving pieces in the U.S. economy, it doesn’t hurt to be covered on all fronts. But who actually has a team of commodities, energy, precious metal, options and penny stock experts at their disposal? Very few people – that is, unless you belong to the Agora Financial Reserve. This elite circle of investors has the best research and investment advice at their fingertips.

*** “Why do you write about your family…and about fixing up houses and so forth,” asks a Dear Reader. “What’s that got to do with finance and economics?”

We don’t know. But we have a feeling that it all fits together somehow. Why do we bother caring about money anyway? Warning: what follows is merely another windy ramble. Direction? Unknown.

In our life, we’ve been rich and we’ve been poor. When we were young, we had no money…

Have we told you this, dear reader?

We lived in a ghetto-house in Baltimore…one we bought for $27,000 in the early ’80s. Your editor scrapped off the old wallpaper, replastered and painted…he tore out old plumbing and put in new pipes and fixtures…he repaired doors…he built kitchen cabinets…he sanded floors – he did practically everything. After two years, the house was a respectable place to live.

But the neighborhood was never respectable. Most of our neighbors lived on welfare checks. Out on the streets, it was noisy, dirty and dangerous. Once, in the middle of the night, our next-door neighbors called.

“Someone’s broken into our house…”

“Call the police…I’ll be right there…”

We jumped into a pair of jeans and picked up a hammer. Arriving at the front door, we found a young fellow with a TV set in his arms on the way out. We raised the hammer.

“Put the TV down…”

“All right…all right…I didn’t mean no harm…”

The police came a few minutes later and took him away. But he was back out on the street a few days later. That’s the way it went in the Baltimore ghetto, now portrayed, very well we’ve heard, in a TV show, The Wire.

Meanwhile, our group of children grew…from three…to four…to five…to six.

At night, the noise seemed to grow louder…and the trash cluttered the alleys.

We got in a fight with a neighbor over it. He was dumping trash in the alley, next to our house. We told him to stop. We were about to come to blows when a gang of his friends got the jump on your editor, knocked him down and bloodied his nose. We sat on the curb. A police car came. By then the gang had run off. We decided it was time to move.

After such rough handling in the black section of the city, we decided to move to the white countryside. This time, we decided to build our own house. But we didn’t have the money. So we built a barn instead…with tractors and farm equipment underneath and a rustic apartment under the tin roof. This was probably the mid or late ’80s…we’ve lost track. It was a remarkably nice place, lined with rough-sawn poplar boards, inside and out.

The whole thing cost us about $15,000. We paid for it in cash, since it was the local banking community was sure we were a bad credit risk. Besides, who was going to lend money for a live-in barn? And if the county had known what we were up to, they never would have allowed it anyway.

We lived in the barn for a couple years. But it was cold in the winter and hot in the summer. We heated with a wood stove and cooled with fans.

But by then things were starting to look up. We had entered our 40s. Business was improving, mostly because we were getting better at it.

Anyway…that’s more than we intended to write on the subject. The point was only that when we look back on those days…they were the happiest days of our life. We were “making do.” We were improvising. We were short on cash…but long on energy and imagination.

And now…is it the other way around? We don’t like to think about it that way…

Today, we still don’t mind painting windows. It’s the loneliness that bothers us. For a quarter century we’ve had helpers – children, who followed us around whenever we put on our working togs.

“Hand me a hammer…bring me a chisel…stir this up…hold this for me…” The work probably went more slowly when the kids helped. But it was more fun for their father, if not for them. (Having grown up with weekends devoted to construction and repair, they will probably all live in furnished, rented apartments…and never touch a paintbrush again in their lives.)

But as we were ordering our little army of helpers around, we imagined that it was good for them. Sitting in school all week…we didn’t want them watching TV or playing computer games on the weekend (this became much more difficult to stop when we moved to Paris and London…where it was hard to get away for the weekend.)

But now pater familias has a new project. A very large house has fallen onto his head. He has to fix it up…he has to take charge of it…he has to exercise dominion over it. He has to pretend that he is 30 years old and it is a house in the Baltimore ghetto…or a barn in the Maryland countryside… He has to go forward, but his thoughts turn back…


We attended the local church on Sunday…after a long absence. In his sermon, the priest seemed to be talking to us…

“What is a flock of sheep without a shepherd? It is lost, in danger…subject to attack by predators… Sheep need a shepherd.”

Later, after church, a neighbor said, “We haven’t seen you in a long time; we thought you’d abandoned the house.”

“Well, it was like a flock of sheep without a shepherd,” we replied. It was a disaster in many ways. But it wasn’t the fault of the house itself. It was the fault of the shepherd, who was absent. After we bought the house, we moved to London, for business reasons. We weren’t able to keep up with it.

So, now we’re back. But we’re back without our tribe of little helpers. All but one have grown up…moved away…or have their own lives to run. The oldest has his own house to fix up. And the youngest, still with us in Paris, has other plans.

Maybe we should adopt.

Until tomorrow,

Bill Bonner
The Daily Reckoning

The Daily Reckoning