Waves of Commodities

Commodity prices could double – or even treble – from current levels, writes Marc Faber. But beware…"Significant downside volatility for individual commodities, even in the context of a long-term commodities bull market, is almost a certainty!"

In the past, I have frequently discussed long-term price cycles and observed, based on research carried out by economists such as Nikolai Kondratieff among many others, that these long waves last between 45 and 60 years, with each rising and declining price wave lasting around 22 to 30 years. These long price cycles are well supported by historical price statistics of the 19th and 20th centuries.

The last commodity rising price wave took place between the mid-1940s and 1980 and was then followed by a declining price wave, which most likely came to an end in 2001, when commodity prices, adjusted for inflation, reached their lowest level in the history of capitalism.

But upon further consideration, while accepting the existence of long price waves for an index of commodities, I have also come to the conclusion that price waves for individual commodities tend to be of far shorter duration. In addition, different commodities move up and down quite independently from each other.

Commodity Price Waves: Suagr Highs and Lows

If we look at sugar, for instance, we find that it peaked out in 1974 at 70 cents per pound, collapsed into late 1978, and then soared once again to a high in the summer of 1980. In other words, within less than ten years, sugar went through two huge price cycles before settling down for the next 20 years or so in a price range of between 2.5 cents and 16 cents.

I am mentioning this fact because investors should be aware that commodities can reach a new all-time high and subsequently new lows within a brief period of time, since during the price boom massive additional supplies are produced that later depress prices. Even if we assume that the long-term commodity price cycle did turn up in 2001, we should also be prepared to occasionally see 50% declines in the prices of individual commodities within a long-term up-cycle.

In other words, investors who are betting on commodity price increases should be aware that significant downside volatility for individual commodities, even in the context of a long-term commodities bull market, is almost a certainty!

This isn’t to say that commodity prices, certain of which have recently seen parabolic increases, will collapse right away. A friend of mine, Richard Strong, once took me to task for being bearish on the U.S. financial markets and asked me why, if Japanese stocks had been selling for 70 times earnings in 1989, the U.S. stock market couldn’t reach similar valuations. Richard proved to be very much on the mark – the Nasdaq sold for even higher valuations in the spring of 2000 than Japanese equities had sold for in 1989. The same rationale could also be applied to the commodities markets.

We could therefore see prices of certain commodities double – or even treble – from their present levels in a speculative mania. This is not a forecast, but a warning to investors of the extremely volatile and short-term nature of bull markets in individual commodities.

Commodity Price Waves: Crude Oil

There is one commodity, however, about which a very bullish long-term fundamental case can be made: crude oil.

Unless the entire Asian region goes into a lengthy recession/depression in the next few years, oil demand will undoubtedly continue to rise. Oil consumption in Asia, with its population of 3.6 billion people, is about 20 million barrels per day (by comparison, oil demand in the U.S., with a population of 285 million, is 22 million barrels per day). Based on demand trends in the last ten years, Asia’s demand for oil is likely to double within the next six to 12 years. This Asian rise in demand, which compares to a total current global oil supply of 78 million barrels, will inevitably mean higher energy prices.

There is also the supply side of the equation to be considered. Recently, Matthew Simmons of Simmons & Company published a very interesting study on Saudi Arabian oil reserves. And while he kept short of forecasting a decline in Saudi oil production, he nevertheless questioned in his analysis the widely held assumption that Saudi Arabia is in a position to meaningfully increase its production of crude oil.

For instance, Simmons raised the possibility that Ghawar, Saudi Arabia’s largest field, with a daily production of five million barrels (by far the largest in the world), could be past its best years. Moreover, based on the experience of declining production at other large oilfields in the world, Simmons’ report suggests that Saudi Arabia’s five super-giant oilfields will at some point (maybe sooner rather than later) also experience declining production.

The possibility of declining oil production isn’t the only problem the Kingdom of Saudi Arabia is facing. Its population has almost quadrupled since 1970 and per-capita incomes have been in a steep downtrend since 1980. It has therefore become increasingly politically unstable and, in addition, its own oil consumption is rising rapidly. Rising oil demand is also common in other Middle Eastern countries whose combined population has increased in the last seven years by more than 40 million, and now numbers around 160 million people. (It is estimated that Middle Eastern countries could by 2015 have more people than the U.S.).

I may add that in 1956, Mr. King Hubbert predicted that U.S. oil production would peak out in the early 1970s. Hubbert was then widely criticized by some oil experts and economists, but in 1971 Hubbert’s prediction came true (see also Figure 6). Hubbert’s methods of oil reserve analysis now predict that a peak in world oil production will occur sometime between 2004 and 2008.

Now, given the certainty that oil demand in Asia and the Middle East will rise substantially (by around 20 million barrels per day over the next ten years or so) and the high probability that world oil production will peak out in the next few years, the fundamentals of crude oil as well as oil companies look very attractive.

Commodity Price Wave: Price Increases of Unimaginable Proportions

What is more, unlike the seventies commodity bull run – when global oil demand was leveling off – the fact that the coming energy crisis will happen in an environment of rapidly growing demand from Asia means it could involve price increases of unimaginable proportions.

And of course, neither Mr. Greenspan nor his lackey Mr. Bernanke will be able to do anything about these price increases! Moreover, if we look at the recent very substantial increase in practically all commodity prices and the behavior of the ISM Prices Paid Index, it strikes me that the CPI figures reported by the U.S. government statisticians cannot make any sense at all to anyone except Mr. Greenspan and Mr. Bernanke. In fact, I wouldn’t be surprised if, one of these days, the bond market woke up to the fact that inflation is far higher than what U.S. CPI followers naively believe, or that bond prices could begin to discount higher inflation rates in the future and sell-off sharply.

In general, however, I would most like to warn investors about short-term volatility in commodity prices – even in those with great fundamentals, such as the energy complex. Although it is true that commodity prices are likely to have begun a long wave-up cycle, which could last for a decade or more, cycles for individual commodities tend to be of far shorter duration. Indiscriminate buying of commodities that are in the midst of a parabolic rise purely on the China demand story, for example, may result in large losses.

Having made this point, however, the view that certain commodity prices may have become vulnerable in the near term doesn’t change the presumption that a long-term (but volatile) commodity up-cycle began in 2001. The future is still quite bright for this sector.


Marc Faber
for The Daily Reckoning
March 30, 2004

Editor’s note: Dr. Marc Faber is the editor of The Gloom, Boom and Doom Report. Headquartered in Hong Kong for 20 years and now based in northern Thailand, Dr. Faber has long specialized in Asian markets and advised major clients seeking bargains with hidden value, unknown to the average investing public. Dr. Faber also writes a regular column for Strategic Investment.

As Dr. Faber writes above, commodities are in a long-term up-cycle…but their upward trend will most likely be highly volatile. If you’d like to play the commodities bull market profitably – and safely – you may be interested in real-time, specific recommendations from a genuine commodities expert. For details, see:

The Biggest Profit Boom in 20 Years

We did not think about investments yesterday. We opened no newspapers; nor did we consult any websites…or even turn on the television…

…which makes us especially qualified to give an opinion on what is going on…

Our opinion is that the tide has turned; after 20…or 50…years of flooding in, it is going out. Almost all boats – that is, asset prices – will sink lower as credit-soaked growth ebbs away.

In America, over the last half century, people gradually shifted from production to consumption. Now, they depend on credit from the rest of the world to continue spending. While they grow older…and look forward to retiring on money they haven’t got…younger, more vigorous workers in China, India, and elsewhere offer to do their jobs at lower rates of pay.

The rally wrought by the feds with lower lending rates and increased public spending was merely a backwash. Now, it seems to have crested. Stocks and the dollar are headed down.

These are just opinions. But at least they are uninformed ones. Many are the ‘facts’ that might be shoved in our faces to prove we are wrong. If we’d read the paper or watched TV, we’d know that houses sold well last month. People bought them by the dozens – as if they were Viagra pills. Consumers continued spending their silly heads off.

Stocks, we see in today’s headlines, rose 128 points yesterday. "Stocks are attractive with earnings growth being pretty good," the International Herald Tribune quoted someone this morning.

Well, there you are: stocks are attractive. All is well. Another item tells us that the dollar is expected to rise, not fall…and that gold "may disappoint" investors.

But that is the trouble with the ‘news.’ People take it seriously. They read the paper and think they know something. But what they know is nothing more than the prejudices and illusions of their fellow investors and media hacks…which they mistake for reality.

You’re better off avoiding it, dear reader. But few people can. An investor, for example, feels the need to ‘inform himself.’ If he doesn’t watch his investments, he fears they may get away from him.

He would do better to go fishing. If he tunes into the news, he finds out what other people already know…and what other people already think. If he finds a stock that sounds appealing, it is usually one the smart money is already selling.

The typical investor does not inform himself in any real way – digging into a company’s annual report and studying its business model as Warren Buffett might do. Instead, he merely absorbs the latest mass sentiments and feels no need to think. Thus does the poor schmuck fulfill his role as a bagman for modern capitalism.

The man without media is in a better position. He knows nothing. But he knows he knows nothing. He can buy and sell in complete ignorance of investment fashion. Immune from the currents of investment fashion…at least he has even odds.

But we give you the news anyway…and urge you not to pay too much attention to it:


Eric Fry, on the ground in Manhattan…

– Up here in the Northeast, the icy shroud of winter is finally lifting, and an occasional crocus is venturing up from beneath the soil. This year, March did indeed come in like a lion, but, mercifully, is going out like a lamb…which may explain the vast flocks of sheep congregating around the Wall Street area.

– As their pinstriped shepherds lead them directly into harm’s way, the sheep repeatedly bleat, "Buuuy…Buuuy."

– Yesterday, the bleating didn’t subside until the Dow Jones Industrials Average had gained 117 points to 10,330 – its second triple-digit gain in the last three sessions – and the Nasdaq had jumped 1.5% to 1,993.

– Despite the market’s recent gains, the Dow and Nasdaq are both nursing losses of more than 2% for the year-to-date…But the sheep don’t care. Better to be slaughtered together, they reason, than to wander alone.

– As usual, yesterday’s stock-buyers found little use for either gold or bonds. The yellow metal slumped $5.20 to $417.00 an ounce, while bonds also fell, pushing the yield on the 10-year Treasury issue up to 3.90% from 3.85% on Friday.

– …And now for your reading pleasure, a monetary riddle courtesy of Dr. Marc Faber, a regular contributor to Strategic Investment and the editor of the Gloom, Boom and Doom Report:

– "He’s the head of a monetary authority who has not only managed to create a series of bubbles in his domestic economy, but has also managed to create bubbles elsewhere – in the New Zealand and Australian dollars, emerging market debts, government bonds, commodities, emerging market equities and capital spending in China."

– Is our mystery man: A) Alan Alda; B) Allen Iverson; C) Alan Abelson or; D) Alan Greenspan?

– The correct answer is, of course, Alan Greenspan. If some of you guessed Allen Iverson, you weren’t far off. It’s true that the flamboyant guard for the Philadelphia 76ers mints money almost as fast as Greenspan does. But unlike the Fed chairman, Iverson is partial to gold, diamonds and other hard assets.

– "Mr. Greenspan’s monetary [machinations] mark an achievement no one else in the history of capitalism has accomplished," says Faber. "It is also one investors will never forget and – once this credit-driven, universal bubble bursts – will fill entire chapters of financial history books with economic and financial horror stories.

– "I was leaning towards the view," Faber continues, "that some assets would continue to increase in value in 2004 while others, such as bonds, would begin to fall by the wayside and enter longer-term bear markets. After further consideration, I am now increasingly concerned that sometime soon ‘everything’ could begin to unravel. When interest rates rise, it is conceivable that bonds, stocks, commodities and real estate will all decline in value at the same time. [Ed note: More on the case for – and against – commodities in today’s guest essay by Marc Faber, below…]

– "As I experienced in Asia in the 1990s," Faber concludes, "it wasn’t important to be ‘asset-rich’ before the crisis of 1997, but to be ‘cash-rich’ after the crisis when financial asset values had tumbled by 90 per cent and when incredible bargains across all asset classes were available."

– Cash-rich is not a bad position to be in, especially if you’ve got the cash to be rich with. As we noted in the Weekend Edition, "Legendary Investors are Drowning in Cash…In fact, it’s remarkable how many top-flight managers currently have more than 20% of assets in cash and say they find compelling opportunities scarce to nonexistent."

– Remember, dear reader, that Warren Buffett, chairman of Berkshire Hathaway, made his billions by buying low and selling high. Is it not significant, therefore, that the Oracle of Omaha is finding almost nothing to buy? At the end of 2003, Berkshire Hathaway held 23% of its assets in cash – up sharply from the single-digit levels of the previous four years.

– "When so many justly respected managers are sounding the same cautious note, it makes sense to listen," says Morningstar’s Greg Wolper. "Even the greatest managers can’t consistently predict the direction of the markets – and by and large, they don’t try to. But right now, their words – and deeds – speak volumes."

– He who has cash to save, let him save.


Bill Bonner, back in London…

*** Well, we’re not in London yet…we’re on the Eurostar en route. We would have been in London, but Daylight Savings Time began in Europe on Sunday. No notice of this was received by our alarm clock.

*** We are still thinking about the way ‘the news’ harms investors…and voters, too.

Economists won a Nobel Prize for describing the way markets adjust to news. The idea was that the stock market was ‘perfect’…or ‘efficient.’ That is, the price of a stock incorporated in it everything that was known about it.

The ‘Efficient Market Hypothesis’ was not exactly wrong, it was merely absurd. It imagined a market with no heart, no soul, no mind. It simply toted up information as an accountant might add up a balance sheet. Every minute of the day the data poured in, and the great machine whizzed up the numbers…without ever misplacing a decimal point.

It was impossible to know any more than the machine. It knew everything there was to know. Thus did it come to the ‘perfect’ price for a stock every second of every day. No investor could do better…or blame himself for failure. He could buy Enron just before it blew up…or Webvan at the height of its hallucination…and who could complain? For hadn’t he bought the stock at the perfect price?

A day later, the price might be half as much, but that is just the charm of the efficient market hypothesis – the new price was perfect, too!

We smile to ourselves. We wish we had thought of it. Elegant. Consistent. Useless.

Imagine the poor investor watching the price of Enron rise. Up and up…each daily news quote would have raised his confidence. The market was clearly telling him that the stock was getting better and better every day. The price was rising…and the price had built into it all that could be known. Mr. Market did not make mistakes. If a price was rising…it was because the price OUGHT to rise. In the democracy of the markets, there was no higher authority than the voters themselves. Mr. Market merely added up their votes and proclaimed each day’s winners.

No, Mr. Market does not make mistakes. But he has a way of changing his mind.

*** Yesterday’s service at St. Peter’s began with a fright. We arrived early, but discovered a line of thousands of tourists waiting to get into church. Metal detectors had been set up; by the time we got through the line, Henry’s confirmation ceremony would be over.

We were about to throw ourselves on the mercy of the Italian security forces when we noticed other parents in the same predicament. Rather than mercy, the French pled privilege.

"We’re expected inside…they’re waiting for us at a special ceremony in the main chapel," said the tall Frenchwoman. At least, that was what we made of it…accompanied by gestures and expressions understood throughout the Latin world. After a few minutes of negotiation, we were let through.

Henry’s class was arranged by height, meticulously, with Henry near the tall end. All the students, dressed in blue and white, boys and girls, stood quietly. Henry, in Rome with his classmates since last Thursday, looked as though he hadn’t slept or brushed his hair. Nor did he seem particularly pleased to see us. But that was the code of the youngsters, we discovered.

"Louis barely looked at us," said one mother. "Foucauld seemed embarrassed that we showed up," said another.

St. Peter’s is what it pretends to be: the most important cathedral in the world…the mother church of the entire catholic world. Angels and archangels and all the company of heaven look down upon camera-toting visitors from painted ceilings, frescos and statues. The voluptuous luxury of the place must be appalling to Baptists. After Vatican II, it is almost an embarrassment to Catholics. But it was a delight to us. We craned out eyes upward until our necks hurt.

*** Readers with ecclesiastic tendencies might be curious about the ceremony itself. Henry has already been confirmed, which is a holy sacrament. This service, his priest explained, is unique to French Catholics. It is a reaffirmation of the baptismal rites…called the "profession of faith."

Parents took their seats in the main chapel. In filed the professors. The ceremony, conducted in French, sounded like a repetition of the baptism. Parents and students alike agreed to renounce the devil. Then, after the devil had been severely renounced, the children marched out, followed by their parents, while tourists took pictures and probably wondered what was going on.

We said our congratulations to Henry and took photos. Then, hardly 10 minutes later, the students were rounded up and hustled off to a pizzeria.

Elizabeth and her husband meandered about for a while…walking around the old part of the city. Finally, we found a delightful little piazza, just to the west of the Piazza Navone. There, in front of the little Hotel Raphael, we had lunch.

"Aren’t we lucky," said Elizabeth. "Who would have thought that our son would celebrate his confirmation at St. Peter’s."

"Yes, especially since we’re not even Catholic."

The Daily Reckoning