"It's always wise to challenge our own investment assumptions. One of mine is that most commodities will in general continue in a bull market for most if not all of the next decade. The reasons for this have been well-rehearsed in Fullermoney commentaries and audios. So what to make of this article from the Financial Times? It's main point seems to be that - like the 1970's - the recent decade of rapidly rising prices, (caused by inadequate supply due to under-investment over the previous two decades) has provided all the incentive needed for supply to increase, and therefore it is argued that the rise in prices is unlikely to continue. My suspicion is that may indeed be the case for some but not all commodities. Can we identify those most likely to remain in supply shortage?"

David Fuller's view Thanks for an email certain to be of interest to a number of subscribers. One could write chapters on this subject but I will confine myself to a few paragraphs and illustrations. There are some relevant points in Peter Tasker's article, although he intentionally oversells them and I need not also discuss the cost of Egyptian slave girls in copper over the last 3000 years, as he does in his conclusion. Here is a selection from the serious stuff:

The noughties commodities boom began in 2001. If the 2008 peak is not breached, the bull market will have been somewhat shorter and weaker than the 1970s blow-off - seven years versus nine years - and a trough-to-peak gain of 150 per cent versus 250 per cent. But in the 1970s consumer price inflation was high. This time inflation has been subdued, meaning that in real terms the trough-to-peak rise in prices was roughly the same. If the commodity markets follow the same pattern as last time, we can expect to see a multi-decade bear market in which prices make a series of all-time lows in real terms.

Bulls would say market conditions have changed out of all recognition, that supply limitations are finally being reached, that fresh discoveries are in ever more remote and inaccessible locations, and that China's insatiable demand for raw materials constitutes a new demand factor. But all these explanations were equally valid 10 years ago when prices were much lower. The currently very high premium of selling prices to extraction costs - as revealed in the super-normal profit margins of the extractors - is the best possible incentive for exploration, also for substitution and conservation.

In reality the new drivers are not so new as they appear at first sight. Industrialisation did not start with China - the post-war reconstructions of Europe and Japan were also "unprecedented" in their time, and technologies such as offshore drilling and deep mining were revolutionary when they first appeared. Historically there has always been a substantial time-lag between rising prices and fresh supply - which is why commodity bull markets are so intense and bear markets so long lasting.

Commodities have not even done their job as risk reducers. During the credit crisis the commodities indices mimicked the gyrations of other risky assets, with the correlation to stock markets of individual commodities such as copper and oil rising to new highs. Unsurprisingly, given the inflows of hot money, commodities have become just another aspect of the global "risk-on/risk-off" trade.

Why have commodities been such a bad investment for so long? The simple answer is that commodities generate no income - as opposed to, for example, equities, which generate the bulk of their long-term return from the reinvestment of dividends. Worse, commodity investors have recently had to endure a negative roll as several of the more popular markets have been forced into contango. The result has been a significant underperformance of ETFs in particular versus the spot markets they are supposed to be tracking.

The key variable with commodities, as I am sure Peter Trasker agrees, is supply. Supply pushed many commodities to all-time real (inflation-adjusted) lows approximately a decade ago and there were also some inflation-adjusted lows. You can see some evidence of this from the CRB Raw Industrial Spot Index (RIND) shown over the last 30 years. Also, here are CPI inflation-adjusted charts for copper, crude oil and corn, the latter showing 50-years of back data. Incidentally, you can see many more of these graphs in the Chart Library's Inflation-Adjusted section and they are not restricted to commodities. For instance, here is a 50-year inflation-adjusted chart of the S&P 500 Index.

What made Fullermoney so excited about commodities a decade ago was that the bear market of approximately 21-year's duration had eliminated most global surpluses in the sector, particularly for industrial commodities, and we were beginning to see the China-led explosion in demand. This emerging Asia-Pacific demand has been vastly greater than anything seen from the post WW2 reconstructions in Japan and Europe, which Peter Trasker refers to, not least because the Asia-Pacific populations are so much larger.

This unprecedented demand, combined with a conservative commodities industry following the long bear market led to Fullermoney's commodity adage of the last decade and counting: "Supply Inelasticity Meets Rising Demand".


We also realised that excessive printing of fiat currencies would increase investor interest in tangible assets that had not already soared in value. Therefore many commodities and gold in particular, had the potential to be both absolute and relative performers. You can see this with the Dow/Gold Ratio, showing the performance of the DJIA divided by the price of gold in USD.

The ongoing case for a secular bull market in commodities is based on both increased demand from the newly affluent rising middle classes in rapidly developing economies around the world, plus the all-important supply factor. Supply does generally follow rising prices higher but producers of industrial commodities, who have to plan and finance development programmes many years in advance, know the risks of swamping the market. There are other risks, including political instability and possible expropriation, windfall taxes, environmental legislation, energy costs, plus equipment and skilled manpower shortages. Therefore producers of resources are generally cautious in their development programmes, if not in the attempts to secure assets in the ground via takeovers.

Well before the 2008-2009 recession Fullermoney mentioned on several occasions that the only factor likely to sidetrack the secular bull or commodity supercycle as we have also referred to it, was an economic slump. We certainly saw this during the stock market meltdown but gold and industrial commodities were among the first to recover. That was an important message. Judging from the CRB chart shown at the beginning of my answer above, commodities have already had a look at their 2008 peak despite the USD's recent firmness, before falling back somewhat during the recent stock market correction. It would be premature to write off higher scope for resources indices, in my view.

Incidentally, both the 2008 spike in crude oil and other commodities such as staple foods, and the subsequent slump later that year, owed a great deal to the fashion for commodity tracker funds. In my view, commodities are for trading, not buy-and-hold, with the possible exception of gold due to the unprecedented printing of fiat currencies. Consequently, I have never been a fan of the various commodity tracker funds which are very costly in terms of the contangos which they exacerbate. Commodities were never intended to be an asset class. I also pointed out during the 2008 oil price spike, which was mainly due to speculation in my view, that if the buy-and-hold investors driving it higher were successful, the consequences would be disastrous for the global economy and most of their other investments.

If one takes a very long-term look at commodity prices, bullish phases have lasted for up to 30 or even 40 years, as Jim Rogers and others have pointed out. I would not count on that occurring this time but the environment still looks positive, if we expect Asia-Pacific GDP growth to continue, as I do. While supply will increase during boom times, production capacity is finite and supply disruptions do occur for various reasons. Overall, commodity prices are often extremely volatile and I do not expect this to change anytime soon. Eoin and I have often said: "Do not pay up for commodities." That is the best advice that I can offer. For traders and active investors, commodities are best viewed as a buy-low-sell-high game. Price charts will continue to show us the opportunities.