Why commodities are the future

Martin Hutchinson, writing in PrudentBear yesterday, explains why he thinks commodities are in a long-term bull market: the developing world wants the "white goods" and other consumer durables that we already have and take for granted.

Marc Faber on the world bubble and his own investments

I have already referred today to Faber's interview on Minesite.com and would like to pull out one or two strands:

Faber thinks "...all real estate markets around the world are in cuckoo land and that they will all correct at some stage meaningfully even if you print money".

Asked whether he has real estate himself, he says, "I own properties in Asia, in New Zealand and in Vietnam in particular and in Thailand, and Indonesia and some in Switzerland; but ... I never borrow money to buy my properties, I pay cash ... I also own gold, and I also own some shares of course, I’m just diversified; but in general, I am very liquid at the present time... I’m holding a lot of cash at all times."

Re precious metals and inflation: "I tell you, the US has no other option but to print money. And they’ll go down like the Roman Empire in a huge hyperinflation. " He is bullish on silver and gold (especially gold), though he notes the danger that in a crisis, the government may simply expropriate investors' holdings of precious metals, as has happened in the US before.

Faber also notes that the expansion in the money supply in the West is not matched by increases in GDP, which is why we have speculative bubbles and a stalled standard of living: "...in the 50s and 60s and 70s if you increased your debt in the United States by $1 you got essentially also a dollar's worth of GDP growth. Now in the last 5 years, total credit market debt in the US has grown by $13 trillion but GDP by just $2.3 trillion." By contrast, in the East, living standards have risen: "I moved to Hong Kong in 1973. When I came, Taiwan, South Korea were very, very poor countries, as well as Singapore was like a dump at that time. Today, Singapore is the richest country in the world and, you see that the standards of living of people, has over the last 30 years, improved very dramatically in these countries. Whereas in Switzerland I go there, back, a few times a year I don’t see any meaningful improvements in the standard of living."

I think I have to speak personally now. What worries me, since I'm not rich and live in a large ex-industrial city, is not how to profit from the crash, as Peter Schiff advises, but what my life is going to be like when my neighbours and their children are strapped for cash, unemployed (or in Mcjobs) and increasingly resentful. Shouldn't we get our noses out of the financial press and start to become concerned about the social cost of the folly and cynicism of our banks and governments?

How long can Japan power world stockmarkets?

An interesting audio file of Gary Dorsch (Global Money Trends, Sir Chartsalot) being interviewed by Jim Puplava (Financial Sense) on 16 June.

He notes UK Chancellor of the Exchequer (i.e. finance minister) Gordon Brown's denial that increases in the money supply are closely correlated with inflation, and says that this is why governments around the world don't raise interest rates fast enough and high enough. (Now that Gordon Brown is Prime Minister, I don't expect a sudden change of heart.)

Dorsch also notes that foreigners are becoming reluctant to keep pumping cash into US Treasury bonds, and bond yields are rising. He regards the yield on the 10-year bond as critical for housing and stockmarket valuations.

He also notes that Japan is resisting rises on its own 10-year bond yield, for fear of a strengthening yen and weakening trade balance; but the rate (c. 2%) is still so incredibly low that traders are borrowing vast sums (the Japanese have $7.5 trillion in bonds, I think Dorsch stated) to invest in global equities. So until there is a significant hike, the "carry trade" will continue to help inflate stocks. He wonders whether at some point, "bond vigilantes" will have enough strength to force an interest rate rise.

Meanwhile, Dorsch notes growing interest in commodities. He likes producing countries such as Canada, Australia and Brazil, and thinks that the ever-growing demand for base metals and energy (especially oil) from China and India will bear them up on the tide.

Puru Saxena: natural resources at bargain prices

Like Jim Puplava, Puru Saxena (yesterday) sees a bull market in commodities, not merely on account of monetary inflation but also in view of increasing demand.

Puplava on the commodities bull market

Jim Puplava's Financial Sense Newshour, July 7: having discussed what he sees as a long bull market in energy, Puplava turns to other commodities such as gold and silver: "the best protection in inflation has always been gold and silver, which represents real money". He sees a new "leg up" in the market within 3 to 6 months, because of the continuing inflationary expansion of money and credit. Another factor will be A&M - "junior producers" being acquired or merged to achieve economies of scale.

So as a hedge against inflation for the small investor, he recommends regular savings into a mutual fund in energy and precious metals, or even commodity ETFs (exchange traded funds) in energy and food.

Listen to Financial Sense!

Click here for the transcript of July 7's edition of Jim Puplava's Financial Sense Newshour. This is a wide-ranging overview, from subprime loans to commodity investing and listeners' queries.

Peak oil, commodity prices, globalisation, back to the land

An interesting article from Tom Stevenson in Britain's Daily Telegraph, on oil. He reaches two conclusions:

1. it's good news for the commodity investor
2. when supply hits its limit, demand will have to change, and so will our lives

The second is far more interesting. I think we will eventually start listening to the dreamers who are even now formulating new currency systems for localised commerce. And we'll need to unwind our dependence on the car. Think of the implications.

Energy crunch = higher food costs

Continuing the theme of energy demands, the Contrarian Investors' Journal comments that the search for alternatives to oil is causing inflation in food prices.

Not yet, the crash - Puru Saxena

Puru Saxena submits "The Solitary Bear" in today's Daily Reckoning Australia. He agrees with Marc Faber that there's bubbles in equities and commodities, but thinks we have some years yet before the crisis hits.

This is because he can't see central bankers having the virility to raise interest rates sufficiently to curb inflation, which is rotting savers' money (the "solitary bear" market being cash). Why the reluctance? "The central banks know full well that with debt at its current level, such drastic measures would probably cause a global depression, widespread unemployment and social unrest. So, they will try and avoid or delay this outcome as much as possible..."

We're practically forced to invest in something. The danger, particularly for small guys, is not knowing when to head for the exit, ahead of the rest of the panicky crowd. It's a tough one:

"...investors will have to become more selective when making decisions and deploying their capital. For maximum success and safety, I would urge you to invest your capital during pullbacks whilst avoiding overstretched markets. Despite all the talk of "doom and gloom", this strategy should continue to deliver reasonable returns in the period ahead."

I wonder whether the "gloom and doom" is in part an oblique reference to Marc Faber, whose website is self-deprecatingly named gloomboomdoom.com. See Faber's comments in the Market Oracle round-table discussion yesterday (previous post) - he, too, admits he can't call the turn but forecasts a continuing rise in equities (except maybe emerging markets) relative to cash - but not a rise in real terms. Faber is looking, I suspect, for quiet bargains in commodities and resources, e.g. low-priced agricultural land.

European sclerosis and a Chinese freebooter

I have just begun reading James Kynge's book, "China shakes the world". He takes as his starting-point the move of the enormous ThyssenKrupp steelworks from the German Ruhr to China in 2002. Lessons are leaping off the page immediately:

1. German steelworkers expected a 30-odd hour working week; the Chinese demolition team worked 12-hour shifts, seven days a week and unmade the factory in a third of the estimated time. The Chinese didn't use safety harnesses and looked like acrobats.

2. The political project of a united Germany had incurred costs that led to higher taxes, which slowed the economy at an already critical time, the late 90s.

3. The Germans were willing to sell the steel plant for its scrap value, because the market for that commodity was in a slump in 2000. But the Chinese man (Shen Wenrong) who bought it could see several things: the slump would eventually come to an end; the plant produced high-quality steel that emerging Chinese car factories would need; buying a second-hand factory meant he could get into production faster and more cheaply.

The writer points out that if the Germans had waited until 2004, the market in steel would have recovered so far that the plant would have been profitable again, in Dortmund, where iron had been made for nearly 200 years.

Doubtless Kynge intends us to see this as a symbolic example: a Europe more concerned with unification and workers' rights, than with global competitiveness; regulation and taxation hobbling the economy; stupid, short-sighted management. (This, by the way, is the Europe that my country seems determined to marry, sans pre-nuptial contract.)

Shen not only foresaw the resurgence of steel, but expects it to collapse again. In 2004 he said:

When the next crash in world steel prices comes, and it will certainly come in the next few years, a lot of our competitors who have bought expensive new equipment from abroad will go bust or be so weighed down by debt that they will not be able to move. At that time you will see that this purchase was good.

Industry and thrift, as per Benjamin Franklin (or indeed any late eighteenth-century enterpreneur). And long-sighted strategy, without the benefit of an MBA. Shen has a tiny desk, takes information by word of mouth and on A4 paper (not plasma screens), and makes fast, one-man decisions all day.

Yet what he does, is no more than what our people once did here.

The natural resources chorus

Doug Casey at "Financial Sense" today reviews asset classes and considers all of them over-valued, excepting natural resources. On Monday, The Mogambo Guru repeated his refrain of "gold, oil and silver", and in an old article of 2005 maintained that even though there may be fluctuations, gold will win against paper. A couple of weeks ago, Antal Fekete noted that physical gold was disappearing fast into private hoards, as it did before the fall of the Roman Empire. Today's Daily Mail article already cited re Diana Choyleva, quotes Julien Garran at Legal & General saying that the "infectious growth environment" of Russia and the Middle East "will, in due course, strain the world's resources and cause inflationary pressure to build."

So how should we bet? Can we beat the mathematics-trained investment gunslingers who are superglued to their computer screens and supported by their massive commercial databases? Perhaps we shouldn't try to get the timing perfect, and instead, work out what asset/s are likely to preserve the value of our savings in the medium to long term. But the answer may not be entirely conventional, in these interesting times.

To sum up... from India

A chartered accountant from India today summarises the general bear case about USA trade deficits and the future of the dollar. Mr Venkatesh apportions some blame to Asian countries, for choosing to keep their currencies weak in order to sustain their trading advantage.

The article is well worth reading in full, in particular the comments on oil and the threat of trading crude in Euros rather than dollars. It is also worrying that...

On March 28, 2006, the Asian Development Bank is reported to have issued a memo, advising members to be ready for a collapse of the US dollar. [see the International Herald Tribune report here.]

Since end March 2006, the US Federal Reserve has stopped publishing the quantum of broad money [...] This is the worst possible signal that the US Federal Reserve could have sent to the world.

[The rise in commodity prices] has led to inflation across the globe. No wonder countries are forced to increase their interest rates to fight inflation. This has triggered an interest rate hike across continents and the US is finding it extremely difficult to sustain its current borrowing programme: it hardly has any elbow room to manoeuvre.

The author says that the US can neither raise interest rates much further, because of the cost of servicing debt, nor lower them, because that may deny it fresh supplies of credit.

Either we are witnessing a global meltdown of the US dollar, or a controlled US dollar devaluation (read, revaluation of other currencies). If it is a global meltdown the global economy is doomed, if is an orderly devaluation, it is damned.

Boom or bust? Cash, shares, property, government promises, or commodities?

The latest posting from The Daily Reckoning Australia includes this exchange:

We got this note the other day, "You say in part, "In markets today, to get along, you have to go long. And if you don't, well you're out of luck." Are you no longer worried about a melt down in the short term? How long is long? One year or two? Your past words of imminent doom had me very worried with its effect on my investment actions, (or inaction ) are you now changing your timeline? I am a daily reader of your investment letter and look forward to your response."

We answer that a melt-down must be preceded by a melt-up. Or in economic terms, a deflationary bust characterised by over production and capacity surpluses must be preceded by an inflationary boom.

We are in the boom phase. And like it or not, related to real value or not, prices are going to rise as global money and credit creation booms. If you're in the markets, you've got to make a choice with your money. So we'll be choosing assets with tangible value that are in economic demand as well.

This is the quandary for a cautious investor. During the inflationary period, cash is not a store of value. In a fair world, if the money supply expands by 13%, then the interest rate on deposits should increase to, say, 16% (allowing for tax) - anything less, and your wealth is being sucked out by an irresponsible government. Which it is. Paradoxically, to be cautious about your wealth, you have to get away from exclusive reliance on cash.

This is because inflation is not transmitted evenly throughout the economy. For example, I estimate that in the last 6 or 7 years, the money supply as measured by M4 (bank private lending) has expanded by around 80% in the UK. Deposits have certainly not returned 80%, but house prices have doubled.

However, borrowing must be repaid sometime - with interest. If a crunch comes and everyone has to pay up, then there will be a desperate shortage of ready money. Even houses can fall in value - whatever you treat like an investment will behave like one. So in the long term, it looks as though the saver has had the last laugh. Cash will be king again.

But the paupers have votes. So democratically-elected governments have a very powerful incentive to print money to put into the voters' hands - even if this means stealing the value of other people's accumulated savings.

No-one knows the timetable for all this, except that it's human nature to delay facing unpleasant situations, so we expect more fudging for a while yet.

Speaking of fudging, how does the government calculate inflation? Do its own "inflation-linked" products really store your wealth safely? Should you buy Treasury Inflation-Protected Securities (TIPS) in the US, or National Savings And Investments Index-Linked Savings Certificates in the UK? If the government gets your taxes and your savings and your investments, it's pretty much got you altogether. Do you trust it that completely?

How about equities? What shares would you buy? If you went into business yourself, how would you try to run it in this very unpredictable situation? Would you borrow cash to expand, risking suddenly having to repay it just as your customers disappeared because of their own money problems? Other than making profits by exporting jobs to low-wage countries (and slowly impoverishing the West), what good business opportunities exist in our wildly gyrating economies?

The Australian bear quoted above is indicating commodities, since the demand for natural resources isn't going to disappear entirely. Intrinsic value is an important consideration for him. If inflation continues, then presumably the price of commodities inflates; if deflation strikes, there will still be some money paid for commodities. Car companies can go bust, but iron and steel will only vary in price.

In a nutshell, it looks as though there's no one type of asset to hold in all conditions. The question instead is, what mix should you have?

Globalisation and economic depression - some strategies

China has its problems. Monsters and Critics, quoting UPI, says that 3.5 million jobs could go if the yuan appreciates much more against the dollar. But if it doesn't, the trade imbalance continues and the economy and stockmarket carry on overheating. So China too is between a rock and a hard place.

In the long run and given free global trade, surely low-wage economies will take work from the higher-wage ones, until we reach equilibrium. It's the rate of change that makes it messy. For people like the Chinese, they have to work out how to take over our manufacturing capacity without bankrupting their biggest customers; for the West, how to lose all this work and wealth and remain democracies.

Richard Duncan thinks it can't be done without some original form of intervention - he suggests a steadily rising minimum wage, to give the worker in the developing economies enough money to take over the job of buying things, a job that we in the West thought was ours for life.

But the implication for us seems clear - we must become poorer. The winners among us will be those who are able to extract capital out of their possessions and preserve it. Marc Faber says that there are bubbles everywhere - property, shares, commodities - but I guess that in a deflationary world there must be something that will increase in value relative to most other things.

Cash seems obvious - the deflation of the Thirties was such that in the UK we had the Geddes Axe, actually cutting the wages of public servants to maintain a steady relationship between money and things (UPDATE: I got Geddes wrong - see HERE - sorry). So public servants who had accumulated savings would have done well - if they had saved. For many others, it was unemployment and poverty. To get an idea of the process and consequences, read "Twopence to cross the Mersey" by Helen Forrester, a real-life story about the economic descent of her middle-class family, which had (typically) lived on credit before the Crash.

Some fear that our governments will shudder at the thought of repeating that period and will try to buy their way out of the jam by printing money, in which case we could go from deflation to hyperinflation, and this is where the gold-bugs raise their voices.

On this analysis, I should think the strategy is clear. First, get out of/avoid debt. Then, live simply, and if possible convert unnecessary assets to cash - which you may partly invest in whatever you think will hold its value. And look for the steadiest job you can find?

What a bear!

I am reading Richard Duncan's book "The Dollar Crisis" and plan to review it in detail here soon.
Meanwhile, searching for information on him, I stumbled across a different, but similarly-named author, Richard C. Duncan, who propounds what he calls "Olduvai Theory". This is a real spine-tingler. It looks at the history of world energy consumption per capita and concludes that we passed the peak a generation ago. He says industrial society is a unique and unrepeatable period, has a life-span of some 100 years, and will decline fast, starting in 2008. I hope he's wrong, but it gives us a terrific motive to look after the world much more carefully.

But instead of concentrating on the fear, which is how journalists sell their papers, let's look at the themes this throws up: increasing world population and everyone's aspiration for a higher standard of living. So there are very powerful driving forces pushing up the demand for food, water, land, metals, and energy sources. This is why the Daily Reckoning says commodities are an asset class that will dominate investment for the next 15 years.

The plain truth about investment

Dan Denning in The Daily Reckoning Australia says today:

"Studies show being in the right asset class accounts for over 90% of your total return in any given investment.

--This happens to be why we are still bullish on Aussie resource stocks despite the China melt-up. Resource stocks are the right asset class to be in right now, and probably for the next 15 years. There will be dips and potholes. But if the asset class is right (and resource stocks made a 200-year low in 2000, so they are still very cheap in historic terms), then the investment maths is really simple."

That's it, unless you're a gunslinger investor and fancy your chances against people who stare at computer screens all day, all week. The world's governments can print all the money they like, but they can't print the resources that turn into things money buys. This is where most bears are bulls.

China goes shopping for the world's resources

China is taking in $20 billion a month of foreign capital, according to this 9 March article from the International Herald Tribune. It has set up an agency to decide how to invest its (now) $1.2 trillion in foreign currency reserves.

There are many implications, some contradictory. Diversification could mean less demand for US Treasury bonds, and if China lends less to America, interest rates could rise in the USA. On the other hand, increasing its holding of other currencies will make it less disruptive for China to let the dollar drop against the yuan.

A stronger yuan will affect some Chinese businesses that trade with America, as previously noted. In a thread discussing America's trade deficit on China Daily, "tradervic" from Chicago says: "Mexico thought it had the cheapest labor market, welcoming all the American companies they could get. Then China showed up with their workforce, and those same American companies left Mexico, leaving the Mexicans running into America looking for jobs. It will be interesting to see what happens when the American companies start pulling out of more factories out China for Vietnam, Bangledesh, and other countries. It is like I told my cousins-in-law in China what happened to my cousins-in-law in Mexico and my immediate family in Detroit: Do not get too used to the jobs - they will not last forever."

I have previously suggested that China may be willing to accept these consequences, to some extent, as part of a strategic economic plan. Just as the Chinese in light industry should not take their jobs for granted, the US cannot rely forever on its bargaining power as one of China's biggest customers.

A Bloomberg article today explains how China is trying to manage the currency appreciation so as to limit the damage in employment terms. It also has a stockmarket bubble on its hands. Did China ever expect that wealth and success could be such a problem?

Now it can also start buying the world's assets. The IHT article quotes Jing Ulrich of J.P. Morgan: "They're not going to be looking for financial assets, but energy assets and natural resources, minerals — things China desperately needs." So bears who look to buy commodities as a hedge against US inflation, may be doubly motivated when they see a big player enter the same market.