Bull and bear: Are we set to see a new phase in the commodity super cycle? - The Share Centre Blog

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Michael Baxter

Bull and bear: Are we set to see a new phase in the commodity super cycle?

Written by: Michael Baxter on June 19th 2013

Category: Bull & Bear, News

Bull and Bear – an optimistic and pessimistic view of investment news. Today’s stories include: Are we set to see a new phase in the commodity super cycle? Is the broader cycle changing too? US medical inflation falls to 50 year low. Japan’s arrows hitting their mark.G8 vows to deal with imbalances. Companies in the news: Chemring Group, Majestic Wines

Are we set to see a new phase in the commodity super cycle?

BP said it in plain English: “In 2012, the US recorded the largest oil and natural gas production increases in the world, and saw the largest gain in oil production in its history.” And so the latest BP Statistical Review of World Energy, June 2013, sets the tone.

Here are some more quotes from the report:  in 2012 “Global oil consumption grew by 890,000 barrels per day (b/d), or 0.9 per cent, below the historical average. Global oil production, in contrast, increased by 1.9 million b/d, or 2.2 per cent.

“OPEC accounted for about three-quarters of the global increase despite a decline in Iranian output (-680,000 b/d) due to international sanctions.

“US net imports fell by 930,000 b/d and are now 36 per cent below their 2005 peak. Conversely, China’s net oil imports grew by 610,000 b/d, 86 per cent of the global increase. Growth in net exports from Canada and North Africa, together with reduced US oil import dependence, offset declining exports from several regions.”

As for gas: “World natural gas consumption grew by 2.2 per cent, below the historical average of 2.7 per cent. Global natural gas production grew by 1.9 per cent.”

The truth is that things are beginning to work the way theory says they should. When commodity price is high, investment in relevant sectors should rise, leading to more supply, leading to falling price, leading to less investment, leading to less supply, leading to a higher price, and the cycle begins again. The last cycle was complicated by the financial crisis of 2008, which resulted in the prolonged recession in many parts of the world, which limited demand, and created uncertainty, and started the crunch on credit, which limited funding available for investment.

But shale gas, the tar sands of Alberta and huge oil finds off the coast of Brazil has changed the dynamics.

But it is not just oil and gas.

In its latest economic outlook, the World Bank stated: “Since early 2011, industrial commodity prices have been weakening, a process that appears to be intensifying in 2013, despite signs that the global economy is gaining strength (figure 18). Indeed, since their peak in early 2011, the price of metals and minerals is down 30 per cent and that of energy is down 14 per cent, with prices off 12 and 5 per cent, respectively, between January 2013 and the end of May 2013.”

The World Bank itself says: “Gradual easing in prices over the projection period remains the most likely outcome,” but that “a steeper decline cannot be ruled out.”

Bull:       For much of the world, falling commodity prices is good news. It is surely no coincidence that the recession suffered in the US, the UK and Europe was so very nasty at a time when oil remained expensive by historical standards. If we are to see a new down phase in the super cycle, then for much of the world, including the UK, the US and euro area, this is to be celebrated.

Bear:     But for countries which rely on exporting commodities, Russia and Brazil being two obvious examples, these circumstances are not so benign. Australia, with high levels of household debt, and house prices may be exposed too.

Is the broader cycle changing too?

We may be entering a new phase in the broader economic cycle too. The last few years have seen cheap money, a prolonged recession in Europe, a weak recovery in the US, and money pouring into emerging markets. This may be set to reverse. And it may be time to start re-thinking many of the assumptions that have underlined investment decisions of the last few years.

Countries with high levels of inflation, high reliance on commodity exports, high levels of either government or household debt, and high reliance on money from oversees funding debt, may be the most dangerously exposed.

US medical care inflation falls to 50 year low

The US spends a lot on medical care, and it is, by all accounts, very inefficient.  Those who say that the US is heading for disaster cite medical care costs, and suggest that later this century they will be so expensive that the US will be all but bankrupt.

According to an article by Chris Cox and Bill Archer published last November in the ‘Wall Street Journal’, “The actual liabilities of the federal government – including Social Security, medicare, and federal employees’ future retirement benefits – already exceed $86.8 trillion, or 550 per cent of US GDP.”

In her book ‘Why the West has lost’, Dambisa Moyo said: “If nothing else changes it from its current path, it is almost certain that America will move from a fully fledged capitalist society of entrepreneurs to a socialist nation within a few decades…The trouble is, it won’t be just any socialist welfare state … the US is on the path to creating the venal form of welfare state (poorly developed and designed) – one born of desperation from many years of flawed economic policies and a society that rapaciously feeds on itself.”

But these statements of doom are based on the assumption that medicare will continue to be highly inefficient and costs will rise faster than inflation for most of this century.

In making these claims about US insolvency, the arch bears are projecting US costs more than 50 years into the future, and discounting them to give a net current value. But an awful lot can change over the next 50 years.

And in fact something rather major did change in May. US medical care costs fell 2.2 per cent year on year, which was the lowest level of inflation in this sector in fifty years.

It may have been a one-off, but one of the problems so-called Obamacare is supposed to address is the chronic inefficiency of the sector. Is it possible we have seen the first signs of this working?

If so, then this may be double good news. Good news for projections on US public debt, and good news for inflation forecasts.

Maybe QE is not so close to ending after all. Let’s see if data for June supports the idea of falling medical costs in the US. If so expect this story to gain a lot of traction.

Japan’s arrows hitting their mark

A communiqué was put out by leaders at the latest G8 meeting yesterday. Here is the bit that related to the economy of the rising sun: “Japan’s growth will be supported by its near-term fiscal stimulus, bold monetary policy and recently announced strategy for promoting private investment. However it will need to address the challenge of defining a credible medium-term fiscal plan.”

Not everyone likes Shinzo Abe’s three arrow approach to attempting to transform Japan’s economy. By engaging in such proactive QE, many accuse it of promoting currency wars. But the G8 seemed to let Mr Abe off the hook, and that has made him even more bullish. Mr Abe now claims that his strategy has won backing from the G8.

And so it was that, as the ink dried on the communiqué, data was released showing that Japanese exports, valued in yen, saw their biggest rise in three years in May.

Is this yet more evidence that Abeonomics is working?

Here is the oddity. Japan didn’t sell more stuff. Rather its exports, valued in yen, rose because the currency was weaker. One dollar now buys more yen. So exports might stay the same, but once their value is converted into yen, a rise is shown.

And by the way, Japan still posted a trade deficit in May.

G8 vows to deal with imbalances

The G8 is good at lots of things, but top of the list comes talking, and second comes an ability to write communiqués that present the appearance of agreement, even if the reality is different. So let’s not make too much of this, but then equally let’s make something of it.

In addition to banging on about tax cooperation, which is a good thing, but let’s see what the reality is (and remember, the problem with tax evasion is not entirely with members of the G8, it is with other countries), the aforementioned G8 communiqué also addressed the issue of global imbalances.

“We reaffirm our commitment to cooperate to achieve a lasting reduction in global imbalances, which surplus and deficit countries must address,” said the communiqué.

If only the G8 really did do more than talk about this. Keynes produced a proposal to solve the issue of global imbalances in 1944. It should have been adopted then, and it should be adopted now.

Maybe we need another crisis, before the world’s leaders take such an idea seriously.

Companies in the news

Bear:     Chemring Group is a manufacturing business in the defence sector supplying high technology electronics and energetic products to over 60 countries around the world. The company has been hit by profit warnings and the departure of its boss. Tempus at the ‘Times’ said: “Chemring is probably at the nadir of its fortunes, but until there is more clarity over US defence spending, the shares will struggle to make much headway.”

Bear:     Majestic Wines has seen a rise in profits as the company sells more wine costing more than £20, more British sparkling wine, and sees internet sales rise. Questor at the ‘Telegraph’ said: “In our view, there is still too much uncertainty.”


These views and comments are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees

Tags: Chemring Group, commodity super cycle, G8 imbalances, Japan exports, Majestic Wines, US medical care inflation, US oil production

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