Commodities to the Moon

The recipe du jour: Sizzle global economy over low interest rates…douse liberally with printing-press dollars…throw in the Oriental spices of growing Indian and Asian consumer demand…et voilà! One order of Commodity Price Inflation, coming right up.

In the 1970s, the United States played fast and loose with its monetary policies. The result was a decade of stagflation and the largest bull market in commodities in over a century.

As we can see, Washington is again busy running the printing presses by pushing interest rates to record lows. True, rates must eventually rise…but the ‘damage’ has been done: Bernanke’s printing press and the lowest rates since Eisenhower’s time have already kicked off a roaring bull market in commodities.

But there is a second and perhaps even more powerful fundamental that will drive commodities throughout this decade – the rampant growth of consumerism. And this time around, it’s not coming from the U.S. (for how could consumerism in the U.S. grow even more prevalent?). Instead, the growth of consumerism is charging from a direction you may not have expected: the East.

The twin towers of the new economy are China and India. Together, these countries sport a population of nearly 2.5 billion, the majority of which is literate, educated and ambitious. China and India are transforming their economies from poor, agrarian nations to the newest industrial powers, replete with heavy industries, mass transportation and higher education. Rising from these giant new economies will come millions of new consumers – the very people who are already straining the natural resources of the Earth.

Commodity Bull Market: Consumers, Middle Income, and Poor

In his book "How Much is Enough?", futurist Alan Durning argues that the world is broken down into three distinct groups arranged by economic wealth. He calls these classes, "consumers, the middle income, and the poor." Consumers make up a little more than one billion of Earth’s 6 billion citizens, and are concentrated in North America, Japan and Western Europe. The poor make up about the same number and are largely represented in Africa.

It is the middle-income class – the 3.5 billion people who live in China, India and Latin America – that will soon place the greatest strain upon the world’s natural resources. Why? Because as they move up the economic ladder, the middle-income class will become a class of consumers. And consumers do exactly as their name suggests – they consume, particularly copious amounts of real assets.

"The emergence of the consumer class society is evident in the skyrocketing consumption that has become the hallmark of our era," writes Durning. "Worldwide, since the mid-20th century, the per capita consumption of copper, energy, steel and timber has approximately doubled; per capita car ownership and cement consumption have quadrupled; plastic use per person has quintupled; per capita aluminum consumption has grown sevenfold; and air travel per person has multiplied 33 times."

This "skyrocketing consumption" of the last half century is about to take off again. Compare China today, for instance, to Japan in 1950 – a largely literate country, determined to work hard and break out of its "middle-class" status. For Japan, this determination resulted in an economic miracle…after which the country enjoyed an abundance of consumer items it could not have dreamt of a half-century ago.

But Earth has paid a price for Japan’s prosperity, just as it has paid for the prosperity of North America and Europe. From 1950 to the mid-1990s, Japan increased its aluminum consumption by more than four times, multiplied its energy needs by five and upped its steel consumption 25 times over.

Japan is a nation of less than 130 million people (and counted only 83 million back in 1950). Apply Japan’s economic growth over the latter half of the 20th century to China’s 1.3 billion people, and India’s 1.1 billion…and the numbers quickly become so big, they’re hard to comprehend.

According to the CIA, "The [Indian] economy has posted an excellent average growth rate of 6% since 1990, reducing poverty by about 10 percentage points. India has large numbers of well-educated people skilled in the English language; India is a major exporter of software services and software workers; the information technology sector leads the strong growth pattern."

Commodity Bull Market: Overtaxing the World’s Resources

The fact is, both nations are willing and able to grow to an extent that will tax the world’s finite resources. The harsh truth is that the world’s richest 1 billion people – just one-sixth of the world’s population – account for three-quarters or more of global consumption of aluminum, chemicals, paper, iron, steel, timber and energy. Imagine what would happen if instead of 1 billion people gobbling up these resources, 2 or even 3 billion people had the same avaricious demand for them?

"If everyone in the world used as much metal, lumber and paper as [the 1 billion] consumers do, mining and logging would jump three-fold." reports the Worldwide Watch Institute.

An even more interesting question for investors is, given rising demand, for what prices will these resources eventually sell? If supply declining, a doubling of demand will not equate to a twofold price increase. Rather, a much greater multiple of price appreciation will occur…one that depends on the severity of the decline.

Take energy, for instance. Even now, with just over 1 billion people consuming three-quarters of the world’s energy prices, oil is sitting at $37 a barrel. If 2 billion people commanded the wealth and exerted the same demand as 1 billion, then without a substitute fuel, oil might look cheap at $100 a barrel!

Of course, before such a price appreciation would occur, substitutes would also come into play. In the case of oil, for example, I believe petroleum refined from projects like Alberta’s Oil Sands is a growing substitute. But even with the billions of dollars invested in substitution projects, given current projections, output can only hope to meet a fraction of the world’s future demand for oil.

The fact is, we cannot afford to ignore an overriding fundamental – a fact that most of Wall Street has yet to recognize: We live at a time when the demand for finite resources is increasing exponentially. And there is no end in sight.

As more analysts and investors finally acknowledge this fact, the prices of the earth’s resources – oil, natural gas, timber, palladium, platinum and even gold – as well as the companies that mine, cut, pump and harvest them, will rise explosively.

Regards,

John Myers
for The Daily Reckoning
April 13, 2004

Editor’s note: John Myers – son of the great goldbug C.V. Myers – is the editor of Outstanding Investments, a monthly advisory on commodities and other hard assets. Our man on the scene in Calgary, John has his fingers on the pulse of natural resource profits – including oil, gas, energy and gold.

As John writes above, the growth of consumerism in Asia and India is pushing commodity prices irresistibly higher. In particular, China is "on the biggest shopping spree in history," writes analyst Eric Roseman, "grabbing every natural commodity she can get her hands on to feed her enormous factories and multiple development projects."

In fact, Eric believes that we’re "on the cusp of a RAGING bull market for raw resources…the largest in investing history." To learn how you can take advantage of it, particularly in light of China’s burgeoning demand.

A new British movie captures the zeitgeist of the time.

"Shaun of the Dead," according to the reviews, is the story of young men so caught up in the puerile distractions of modern city life that for the entire first half of the movie, they fail to notice that the place is being taken over by the Undead.

The heroes go about their business – watching
TV, playing video games, kvetching about girlfriends – while London is invaded by an "army of the undead"…mean, drooling, shuffling, mutilated, putrefying, festering zombies.

But on Oxford Street, who would notice?

The gist of the news for the last few days is that everything is all right. Beck and Posh are just fine, thank you. And hardly a day passes without some fresh evidence that the recovery in the U.S. is for real…here to stay…getting better and better…forever and ever…amen and hallelujah.

Alone in the wilderness of central London, we don’t think so. Everywhere we look, we see something wicked coming our way.

We can’t prove it, but we think the Dow has seen its top for this part of the cycle. Stocks are still walking…but the rally is dead. EBay trades at a P/E of 113. Yahoo is at 151 times earnings. EMC and PFE are both over 50…and MSFT has a P/E of 31. We doubt they will go higher…and we doubt we will see the Dow – for at least another 10 years or so – again at its high of 10,779, set last February 11.

Again, we have no proof, but it appears to us that the consumer borrowing and spending binge has run its course, too. Americans are still buying other peoples’ products with other peoples’ money…but they do so like zombies, not like lively consumers with real money to spend. More senior citizens are going bankrupt, says the Atlanta paper. From Milwaukee comes news that the number of people in danger of getting power cut off is up 11% since last year.

Even with the Fed’s key lending rate at an ’emergency’ level of 1%, people are still having trouble keeping up with interest payments. The great upsurge in refinancing debt probably died when long-term mortgage rates turned up a few weeks ago. And it didn’t help that gasoline prices hit record highs, either.

We have a feeling, too, that last month’s phony jobs report marked not the spanking birth of an employment boom…but the death rattle of a dying economy. When we looked carefully at the numbers, we found that fewer people were actually working…and those who were working earned less money!

Employment, stocks, bonds, consumer spending – as far as we can tell, the headlines are nothing more than yesterday’s news…like the sparkles of an extinct star. Day by day, the real economy dies a little death…while more and more zombies walk the streets – consumers, borrowers, stockbuyers. And yet, no one notices.

But here’s Eric with more news:

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Eric Fry in high-powered Manhattan…

– "Whoa!…Check out the rims on that Escalade!" gasped your New York editor’s son, while strolling through the New York Auto Show. "Those things are huge!"

– The car-obsessed 11-year then jostled into a crowd of car-obsessed 40-year olds to get a closer look at the 26-inch chrome rims adorning the "pimped out" Cadillac SUV…Nearby, another large crowd of SUV aficionados huddled around a glistening Hummer H2.

– Massive, gaudy SUVs seemed to populate the entire convention floor, as nearly every auto manufacturer in the world displayed its me-too version of a gas-guzzling 4-wheel drive. A few car companies also showed off obscenely over-powered vehicles like the 626-horsepower Mercedes McLaren or the 850-horsepower Chrysler ME Four-Twelve.

– One specific message from the New York Auto Show came through as loud and clear as the roar of a 500-horsepower Dodge Viper engine: raw power is in; fuel efficiency is out. The average American car-buyer doesn’t seem too care where the next gallon of gasoline will come from…nor how much it will cost. Muscle-bound cars and trucks are rolling off Detroit production lines at a record clip, even as gasoline prices soar to record highs.

– Gasoline prices jumped yesterday to the highest level in two decades. Sparking the rally was news that the International Energy Agency had increased its forecast for global petroleum demand for the sixth straight month. According to the Paris-based organization, daily use of gasoline, diesel and other fuels will rise this year by 1.7 million barrels to almost 80.3 million barrels, the biggest gain since 1997.

– In the wake of the shocking forecast, gasoline for May delivery soared 2.6% on the New York Mercantile Exchange to a $1.18 a gallon – the highest closing price since the contract began trading in 1984. Shares of U.S. oil refiners also soared. The longtime Strategic Investment pick, Valero Energy, jumped 4% yesterday to $60.25…The price of gasoline has jumped nearly 40 percent over the past 12 months and still shows no hint of "rally fatigue."

– Crude oil futures also advanced yesterday – up 70 cents to $37.84 a barrel. The inflationary messages from the energy markets didn’t bother the stock-buying lumps one bit. They bought stocks as confidently as they would mortgage their houses to lease a fully loaded Lincoln Navigator.

– The Dow Jones Industrial Average gained 74 points to 10,516, while the Nasdaq Composite rose 13 points to 2,065. But the bond market may have detected the scent of inflation, as Treasury prices fell for the sixth session in seven and the benchmark 10-year yield rose to a three-month high of 4.23%.

– A few remarks from a Fed President may have also riled bond investors. In a weekend interview in the San Francisco Chronicle, Federal Reserve President Robert Parry predicted that U.S. interest rates would be heading higher.

– "At some point, interest rates will be rising," said Parry. "There is no question about that. Interest rates are not going to remain at their current levels – certainly the federal funds rate can’t remain at 1 percent forever. Let’s assume inflation averages 1 to 2 percent. Then you could see maybe the natural (federal) funds rate would be, I don’t know, 3.5 percent, something like that."

– Hmmm…a tripling of short-term interest rates would probably not boost share prices or bond prices or home prices…Come to think of it, a tripling of interest rates might also suck a little horsepower out of the demand for $60,000 Cadillac Escalades.

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Bill Bonner, back in London…

*** If mortgage rates are headed up, what will happen to mortgage debtors?

"I just frankly think there’s going to be a lot of foreclosures coming up in the next two or three years," said Mark Prather, president and CEO of Mark1 Mortgage Inc., to the Long Beach paper.

The report continues:

"Mark1 has seen an explosion of growth during the housing boom of the last three years.

"’Last year was a banner year. We did over $800 million in loan volume,’ Prather said. ‘It’s been three record-breaking years in a row.’

"The mortgage market has been nearly in chaos thanks to California’s housing boom, as people scramble to purchase homes and those with homes seek to take advantage of low interest rates by refinancing.

"Loan companies, too, have scrambled to take advantage of the market, increasing staff sizes to handle the influx of paperwork, and finding ‘creative’ methods to secure home loans for families, even those who would not normally qualify. But in Prather’s view, some companies in the mortgage industry border on being ‘predatory’ lenders.

"One way to qualify someone for a home loan, particularly first-time homebuyers, is to use an adjustable mortgage, in which rates fluctuate. This allows lenders to make riskier loans to those who earn less, or have a poor credit rating, or both. While many cite adjustable mortgages as a good way to get first-time buyers into a home, others caution that some adjustable mortgages may not be in the best interest of everyone.

"’We’ve had this run up in real estate prices in the last three years because interest rates are so low, and people let their emotions get the best of them,’ Prather said. ‘In business, the greater the risk that’s out there, the greater the return that an investor is looking for.’

"That means some people are getting into the market any way they can. For example, Prather said he’s witnessed creditors offer 100 percent financing to people with marginal credit, without even verifying their income.

"Another of Prather’s concerns is ‘interest only’ loans. This is where a lender gives a 30-year fixed rate loan, but instead of the ‘fixed rate’ method of using a certain percentage of the home payment toward the principal and the rest toward the interest, the buyer pays only the interest during the early stages of the loan.

"’Those are real popular right now,’ Prather said.

"But when interest rates begin to rise, homebuyers with such loans may face exploding house payments, and because they’ve paid nothing on the principal, they won’t be able to refinance when rates go back up, Prather warns."

*** Here’s a man-bites-dog story. Argentina is famous for tango and inflation. But, recently, its peso has been so strong against the dollar that Argentina’s central bankers have had to do what the Japanese have done – buy dollars in order to keep their own currency from rising.

*** Speaking of Japan, it has been a long time since we first noticed the parallels between Japan, Inc. and the U.S. miracle economy. In the late ’90s, we wrote so much about the similarities that readers got sick of the subject. Besides, when the U.S. market topped out in January of 2000 – almost exactly 10 years after the peak in Tokyo – it seemed as though the prophecy had been realized. Our work done, readers told us, we could shut up.

But what is this? Along comes our old friend Mark Hulbert, on CBS Market Watch, pointing out the "Scary parallels with Japan" AFTER the top. Referring to a newsletter called Wall Street Winners, Hulbert explains:

"They believe we should seriously consider the degrees to which the U.S. bear market that began in 2000 has been eerily similar to the Japanese bear market that began in late 1989. [Actually, it began in January 1990, by our reckoning.]

"To the extent these parallels are to be taken seriously, of course, the U.S. bear market is far from over."

Quoting Wall Street Winners:

"It’s been exactly four years since the major top in the S&P 500 and one would think that an overlay…[between the S&P 500] over the past 4 years and the Nikkei…from 1989 to 1993 wouldn’t hold true – that it would diverge at some point. It’s not happening. We wanted to shrug that chart off as we’ve seen it many times over the past couple of years. The sad part is that no matter how ‘rational’ you feel in dismissing it, it comes back to haunt you every time.

"Every major selloff and every major rally correspond to each other on both charts. Sometimes they’re bigger on the Nikkei, sometimes they’re bigger on the S&P, sometimes they’re off by a month or two – but ALL of them are there."

What new prophesy do the charts give us?

They suggest, according to WSW, a "selloff of 20 to 25 percent in the next month or so, to below 1,000."