Has bull run in commodities peaked? Experts discuss

In the past quarter a clutch of leading brokerages and experts have argued that the commodities bull run that began in 1999 has peaked and the data from the past year is supportive.

The Reuters CRB commodities index has fallen 22% in the past one year and 14% since the start of 2012. In contrast the S&P 500, the equities benchmark index is flat year on year and up 5% since January 2012. Economists like Ruchir Sharma of Morgan Stanley and Edward Morse of Citigroup argued that the inevitable slowing down of China will prick the commodities super cycle. Sharma said while china accounted for 4.1% of the global iron ore consumption in 1990, it consumed 63.7% of global iron ore in 2011. China's aluminium consumption went up from 4.5% of world demand in 1990 to 43% in 2011. Chinese copper demand shot up from 6.5% to 38% of world demand in the same period. But China can't proceed at the same pace said Edward Morse of Citi because its investment phase is over. According to him, Chinese per capita steel consumption at 500 kilos per head is very high; equal to the peak levels that US and Europe reached in 1974. Also, China's investment pace at 50% of its GDP is at peak levels; Japan peaked at 38% of GDP and Korea at 40% of GDP. Inevitably, China will invest less and that means the commodities super cycle is over, he said. In an interview to CNBC-TV18's Latha Venkatesh Commodities Guru, Jim Rogers and Gerard Lyons, economist with Standard Chartered Bank share their perspective on the same. Rogers in his book 'Hot Commodities - How Any One Can Invest Profitability In The Worlds Best Market', which was launched in 2005 strongly urges to invest in commodities. Below is the edited transcript of the interview. Also watch the accompanying videos. Q: You were among the first to spot the commodity super cycle but given the imminent slow down of the global economy would you say the cycle is peaking? Rogers: Cycles don’t go back into a bear market until supply demand get out of balance and there is too much supply. There has been virtually no supply of anything in the past 10 years. Agriculture inventories are the lowest in almost in recorded history. The average age of farmers in America is 58, in Japan it is 66. It is not a whole lot of new supply in agriculture. I don’t know where the whole lot of new supply – the IEA says that no reserves of oil are in steady decline. We were losing the oil reserves that we have. We are having an economic slowdown which is going to get worse but that this not the end of a bull market. That is just a normal correction on an ongoing bull market. Q: Where do you stand in this argument? In the past quarter at least three brokerages have called an end to the commodities super cycle but Jim Rogers here thinks that the current downturn is only a cyclical correction in an ongoing bull market – which argument do you go with? Lyons: The latter part of argument is more valid one, but the comments of the former, which is of a significant change still need to be taken into account. I think the underlying trend is up, but there will clearly be setbacks along the way. The underlying trend is up because of the strong continuous demand from China and India. But quite clearly those economies are at a stage of cycle where in the past they have encountered problems. We see that recently in China and we have seen it definitely in the last six months or so in India. So that clearly impacts things. What we have seen recently in the commodities space is that the markets are reacting to this cyclical slowdown. So this cyclical slowdown is significant, it shouldn’t be dismissed, it shouldn’t be overlooked. At same time that strong underlying demand trend is very evident. The important thing when you look at the commodities space is to remember of course that one of the key driver is not just demand, it has also been the inability of difficulty of supply to response to that demand. What we have seen particularly in the last couple of years is significant upward investment in commodity producing areas and commodity producing regions. Now, depending on the commodity that investment will take some time to lead to higher supply. So, we are likely to see significant increases in supply of different commodities at various stages over coming years. Therefore, it is very important within the broader story about commodities not to overlook the specifics in terms of demand and supply in different sectors. Maybe to conclude I think the key thing is to view what is happening in the US shale gas space as an example of how a particular market can be impacted by the increase in supply and how that can change near term dynamics and certainly market expectations as well. So I think positive story is there, but don’t overlook the near term negative cyclical factors and there are industry specific instances in different markets that come into play. Q: There are bunch of observers who believe that increased findings of shale gas and improvement in the technology making it cheaper as well as new oil and gas finds will put a lid on energy prices. Where do you stand on that? Rogers: Of course it does, it already has improved the supply of gas in the United States. But if you look at other parts of the world the price of gas has not gone down. People look at gas because gas trades on exchange in America but that's not all the gas. If you look at shale gas you will see that the number of drilling rigs drilling for shale gas have gone down by 70-80% in the last few years and it is back to where it was in 1999. We had temporary glut of shale gas in the US, but the very definition is its ending the glut because the drilling rigs are going elsewhere now. The shale gas reserves at least the wells are very short-lived reserves, the production starts at 100%, it goes down very quickly and in two-three years the production is petered out. _PAGEBREAK_ Q: The Citibank report points out that Chinese investment rate at 50% of the GDP cannot get any better. Most countries like Korea and Japan have seen their investment pace peak off even at lower levels. So Chinese investment demand has to peak off, the Chinese in fact are doing it by mandate? Lyons: I cannot comment on other bank’s report that I haven’t read, but it’s highlighted some important issues. Again, one needs clearer perspective of longer term and short-term macro trends, also important to look at certain characteristics in different parts of the commodity markets. When you look at China, it is important to keep in mind that investment linked commodities could be impacted by the desire of Chinese to slow the pace of investment growth. Investment in China is 48% to GDP. The Chinese want to get that down to 38-40%to GDP. So it’s a significant deceleration there. But relative to global picture, investment globally is about 22-23% to GDP in certain economies. So the point is that even in China even though they are trying to squeeze their investment component as proportionate to GDP is still going to be far higher than in a typical economy elsewhere and that is why you can see aluminum in commodities linked to their urbanization, their industrialization process doing quite well. Then of course  the Chinese consumption is proportionate to GDP, government and private is 48%. The Chinese want to get that ratio close to 75-80%. That is a phenomenal boost to consumption, not just government led in the near-term but private sector led and again has a big impact. The green economy is going to be particularly important in China. So it’s important that when people make comparisons between China and other countries they don’t just take the headline figures and think that’s the end of the story. It’s a far more precise analysis that needed. But likewise in India if you look at the Western south of India that’s a very different economy to the bulk of the rest of India. Infrastructure investment is going to be a big issue in India once the politicians get their act together. So again in India it’s going to be a specific story. I would hesitate to start to be too general in some of the comments and to suddenly conclude this is the end of the game. World economy going through big structural shift, but in the near term there are significant downside risks as well as in the longer term there is significant upward trends across the emerging world. Q: What is your take on the inevitable Chinese slowdown? Rogers: China has been important to all of us in the past decade but the European, American and Japanese economies are ten times, 1,000% bigger than the Chinese economy. So even though demand is certainly grown a lot in China its also build a lot of demand growth in the rest of the world at the same time when supply has been under due rest everywhere. Many parts of the world including China are having an economic slowdown. You are going to see reductions of demand – that’s does not end the bull market. That’s a cyclical slowdown within a bull market. Q: Citibank says the china steel consumption has hit 500 kilos per capita, US and Europe peaked their steel consumption at about 400-500 kilos. So Chinese demand either plateaus or falls off from here and that could bring down the commodity super cycle with it? Rogers: What steel got to do with the commodities bull market? Yes, if they are right and I do not know if they are right or not. I do not pay too much attention to steel. I sounds like steel will be under due rest, but let me remind you that China is 1/10th the size of America, Europe and Japan all of which have problems. But there are other countries in the world that are continuing to do well. Steel may well be having excess capacity and by the way there is a difference in steel production capacity and in the underlying asset which is iron ore and of course coal. _PAGEBREAK_ Q: Speaking of other larger economies, even if you look at the other nine parts of the global economy, Europe looks like it is set to be in a recession for several years now and Japan remains in that state near recession stage for some time now and a very slow growth in the US is the most optimistic estimate, some believe even a double dip cannot be ruled in the US. Won’t all this hurt commodity demand for a sustained period? Rogers: Maybe I am not making myself clear but let me try again. Yes, we are having economic problems around the world now. Europe, America, Japan, China, everybody is having economic problems which will lead to reduce demand for a while. But do you think stocks are going to go up in a situation like that. You are talking about the rest of the world having troubles and that may well be. I would rather own commodities where there are supply problems than stocks because government will then print a lot of money and throughout history when government print money the way to protect yourself and to make money is to own real asset. You just outlined two-three times scenarios which I have tried to say the same thing. Yes, the world has economic problems facing it. Yes, we are going to have reduced demand for everything but in that kind of a scenario I would rather own commodities and be short stocks which is my position and some currencies than the other way around. I guess Citibank want to own stocks in the next few years. I am short stocks. Q: You and Jim Rogers agree there will be an intermediate cyclical downturn before perhaps the commodities bull run asserts itself again. How long will prices remain sober, commodity prices? Lyons: If we look at the world economy of recent years we get an indication of how complex the picture is. The world economy in 2010 grew about 4.3% that was a pretty healthy rate of growth. Last year 2011 the world economy was scudding an earning growth of 3%, this year seems that the world economy could grow somewhere around 2.5%, next year the world economy might gather momentum as we move into next year and start to pick up growing around 3% plus. What we have at the moment is that the west continues to be hit by the overhang of debt and need to deleverage, but at the same time emerging economies having had a couple of good years of strong growth even after the financial crisis in the west, the emerging economies are now stated a cycle where in the past they would have run into problems. In India in the past, we have run into trade, into inflation problems. In China in the past they have run into imbalances as well. So hence the Chinese are easing significantly and hence the Indians are having to try and get themselves out of this situation where inflation is high, but at the same time the economy is slowing. Therefore the key messages that the trend in the economy such as India and China is in an upward trend, but the business cycle does exist and you should expect setbacks along the way. The fact that there is a set back does not mean it is the end of story, it would be no surprise if there is a set back in India or in China and consequent there is no surprise if there is a set back in the commodity producing world as well. Q: How long do you think the commodity super cycle can last? Lyons: The trouble with cycles is that you cannot think of too much investment coming in and that is the challenge. Not just investment in the hard physical assets but also speculative investment in terms of the markets and the different funds. But overall I would expect it to go on for a few more years despite a slowdown in the near term. It is clear that when you look at the world economy there is significant upward trend in terms of how the world economy is growing. Look at the last couple of years, beginning of this century the world economy was a 32 trillion dollar world economy. We think when Lehman Brothers went bust it was a 62 trillion dollar world economy. At the end of this calendar year, it is going to be a 72 trillion dollar world economy. I think it is going to go on for a few more years. Q: Which commodities would you bet most on? What would say top three commodity bets be? Rogers: Let me repeat what I said twice already. Agriculture is the best sector of the world economy. We are going to see very serious shortages in agriculture going forward. Prices in agriculture going to astonish all of us including me. We are running out of farmers. The average age of farmers in Canada is highest in recorded history and in Australia it is 58, we don’t have enough farmers. Agriculture prices are going to go much-much higher.