There are plenty of expensive assets in the world today. The past decade of loose monetary policy and central bank money dumps have created the infamous “bubble in everything”. This is one reason we now have the bizarrely yo-yoing investment environment that we do, in which everything from risky stocks to safe gold is rising at the same time.
But one thing has remained reliably cheap — commodities. While the US equity market, which keeps ratcheting up to new highs, is almost as expensive as in the past 150 years, commodities are about as cheap relative to stocks as they’ve been in the past century.
Part of this is natural — and structural. Over the past 200 years, the real price of industrial commodities has been trending downwards. That’s because every time a new peak in prices disrupts what is usually a long-term bear market, companies and consumers adjust. They might substitute in a cheaper commodity for a more expensive one, develop technologies that allow more efficient extraction or (gasp) actually try conserving energy. On that note, who in my generation can forget Jimmy Carter’s 1977 presidential plea, amid an energy crisis, for Americans to turn down their thermostats, which he delivered from the White House while wearing a thick cardigan?
With the exception of a couple of spikes, industrial commodity prices have been falling relative to the S&P 500 ever since. And most people think there’s good reason for that to continue.
In a deflationary world, at the tail-end of a recovery cycle, with ageing populations consuming less and a global economy that’s less dependent on commodity-heavy manufacturing relative to services, there are plenty of factors keeping commodities cheap, even if we don’t experience a recession in the US or the rest of the world.
Add to these factors the wild card of an escalating US-Iran conflict, as well as a global push towards greater action to prevent climate change. The latter may not be a priority for the US administration, but it is for the young activists who make up a growing share of voters.
Like most chief executives, economists and policymakers, younger generations believe a shift further away from fossil fuels is inevitable. In investment circles, there’s even talk of oil tankers becoming “stranded assets”, whose value will fall precipitously as renewable energy takes centre stage.
And yet, having watched the last big demand-driven oil spike in 2008, as well as the more financially driven price spike in 2011-12, which eventually came undone when central bankers pulled back on quantitative easing, I think it’s unwise to assume that we have entered a permanent bear market in commodities — at least not yet.
The looming threat of unfunded US pension and healthcare entitlements, coupled with the willingness of central bankers and policymakers to try to inflate it away by printing money — thus weakening the dollar — could make gold the hottest new asset class of the next few years. Some of the same trends could lead to an upsurge in commodity prices more broadly, even though the prospect of a wider war starting in the Middle East hasn’t yet created a sustained oil spike.
There are plenty of reasons — from deficit spending, to political risk or the popping of a corporate debt bubble — for the dollar to weaken. If that happens, commodities, which move inversely to the dollar, would rise. The US stock market would be likely to fall, since corporate margins are tight and there’s not much room to buffer against rising energy and input prices. If the dollar weakens, all costs from overseas supply chains rise too.
Should that come to pass, there’s little doubt that the US Federal Reserve would try to bolster the market with further monetary easing. But given that every central banker in the world is telling us that monetary policy can’t prop up the market forever, it’s possible that such a move would trigger not a further rise in stocks, but a stampede towards gold and perhaps towards the commodity asset class in general.
QE was a major factor in the last run-up in commodity prices, which aren’t just raw materials for business, but tradable assets for speculators. And this is a theory that is currently being bandied about by some momentum investors.
This scenario would only play out if there was no significant collapse in global growth that changed the underlying demand picture. But it is possible that things could go the other way, particularly if growth in Europe or China started to falter alongside the US.
Still, if commodity prices did rise, there would be myriad ramifications. You would start to see the heads of petro states further emboldened, and populist nationalism increase globally — inflation in food and fuel prices hits the poor hardest, encouraging political volatility. That could, in turn, create new trade turmoil and the sort of disruption that the markets are currently discounting.
On the upside, though, demand for commodities is price elastic — once prices go too high, demand always falls. The cycle of replacing one source of energy with another has been playing out for hundreds of years, and continues. In an ideal world, the next commodities bubble, whenever it comes, could help us make what might be the final shift — away from fossil fuels and towards renewables.