The 3 Killer Cs - Cyclical, Capital-intensive and Commoditised

"The 3 Killer Cs"

Not one but three 'killer Cs' lurk around the darkest corners of the business world. 

If any one of them grips a business, it makes life hell for the managers and profits elusive for the owners. What are they? 

The first is 'cyclical'. 

• When a business is cyclical, it sees large and unpredictable swings in its revenues, margins, and profits. Everything that matters is all over the place. 

The second is 'capital-intensive'. 

• Businesses afflicted by high capital-intensity require a lot to produce little. They s u  c k investors dry as they need large amounts of capital to make profits. 

The third is 'commoditised'. 

• Companies here can do very little to prove to customers that their product or service is better than their competitor's. 

The presence of even one of these killer Cs is bad news for a business. 

How low can the Aussie dollar go?

There are five key influences on the Australian dollar and each offers a clue as to how low the dollar might fall.

It’s now almost 30 years since the float of the Australian dollar and rarely has it been stronger than in the past few years.

Only now are investors, surprised at the rapidity of the recent drop, waking up to this fact. The economy is starting to feel it too, with Ford closing down local operations, local tourism struggling as Australians head overseas and now Holden giving an ultimatum to staff: accept pay cuts or risk losing your job.

Many people explain away this strength with the phrase ‘‘commodities boom’’, but it’s more complex than that.

There are five key influences on the Australian dollar and each in its own way offers a clue as to how low the dollar might fall.

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1. Interest rates

If you can borrow at 0.25 per cent in Europe, the US or Japan and can invest it in Australian bonds, assets or bank accounts paying 3-4 per cent, plus capital gains, why wouldn’t you?

National Australia Bank recently estimated that the upward pressure on the local currency as a result of the US Federal Reserve’s zero interest rate and their quantitative easing program could be worth as much as 20 cents in the Aussie.

And of course, those global investors could look at the Reserve Bank and feel pretty safe that if it were to reduce rates, it would do so cautiously and gradually.

For the last few years, Australia has been a giant post box for international hot money. Right now, that reputation is under pressure.

2. Global and Australian growth

In addition to relatively high rates, global investors flocked to Australia after 2009 due to the resilience of the Australian economy, assisted by local and Chinese stimulus.

We didn’t have a housing crash and we didn’t follow the US and UK economies into deep recession, which is why we became a safe harbour.

3. The US dollar

The US dollar is the most under-appreciated driver of the Aussie dollar.

Traders and investors talk about growth, interest rates, the mining boom, the budget position and household debt, but on the other side of the AUD/USD currency pair the same questions are asked of the US as an input into the Aussie.

The perceived value of the US dollar is an important factor in the relative price of the Aussie and, after a long period of weakness, it’s likely to grow in strength.

4. Investor sentiment

When we see a convergence of major drivers like this, investor sentiment itself becomes a fourth driver. Here, we enter the currency expectations market.

Since 2009 large speculators – hedge funds and the like – have been supporters of the Aussie dollar for all but a brief period of market instability in the middle of last year when the euro teetered.

Generally, global speculators have been supporters of the Australian dollar since the global financial crisis. That is now on the verge of a reversal.

5. Technicals

The Aussie has had strong technical chart since the GFC: every new move led to a new high and every dip was followed by a rebound. Even as volatility reached extreme levels in the past few years, the chart for the Aussie remained indomitable. Its safe-harbour status was never breached in a technical sense. That encouraged speculators and investors to buy the dips whenever global trouble loomed.

That’s how we got to where we are. To see where we might go, let’s examine these five key drivers from the other angle.

Australian interest rates are falling much further than most forecasters anticipated. The main cause is that Chinese growth is slowing faster than many expected (although not us), pushing down the key export prices that drove Australia’s commodity boom. As a result, mining projects have been cancelled en masse. Yet the boom ran long enough for mining companies to believe it would last.

Even with the cancelled projects, lots of new supply is on the way, just as China slows. This will drive commodity prices down further still.

The likelihood is that Chinese and Australian growth, and Australian interest rates, will fall further. So although the carry trade into the dollar is still positive, with declining yields and an increased risk of capital loss, it now faces more headwinds.

To make matters more difficult for the Aussie, the US housing market is recovering. Although fiscal challenges loom and monetary policy is still very loose, markets are beginning to price in stabilisation to the former and a tightening in the latter.

In the passing beauty parade of foreign exchange, the US dollar is being viewed as the least ugly. As the US dollar index rises it is hitting a variety of asset classes, including gold and the Aussie dollar.

Sentiment among hedge funds and speculative traders – see recent comments by George Soros and Stanley Druckenmiller – has turned against our currency.

As recently as April this year, the Aussie was trading above $US1.05 before the recent fall took it to around $US0.92. That’s a fall of about 12 per cent.

So, how low can it go?

NAB recently suggested the $A could fall to 87 US cents by December 2014. But let’s remember that for all the extreme recent calls about the crash in the Aussie and the impending doom facing it, the reality is that it is simply back at the bottom of what might be considered a wide 10-15 cent range it has been in since breaking up through 94 US cents in mid-2010.

This sell-off is not all that shocking and the forecasters of doom forget this.

A fall below 94 cents would signal a different and lower scenario. Our assessment is that this is likely, especially if the economy weakens due to the withdrawal of mining investment, assuming consumption doesn’t fill the gap.

That may necessitate rate cuts to 2 per cent or just below.

Despite the recent highs, the Aussie dollar’s average remains steadfastly around 75 US cents. It may not revert to the mean but after 22 years without a recession, you wouldn’t want to bet on it.

What might happen if Australia did have a recession?

The answer was offered during the GFC low when global investors believed that was about to happen. Back then it fell to $US0.5960. There’s your answer.

To protect your portfolio against that possibility, and to hedge against falling interest rates, Intelligent Investor Share Advisor has recommended allocating a portion of your portfolio to overseas markets. Each of its model portfolios has an allocation to businesses that stand to benefit from a falling Aussie dollar.

This article contains general investment advice only (under AFSL 282288).

By Greg McKenna and David Llewellyn-Smith of MacroBusiness, in conjunction with Intelligent Investor Share Advisor, shares.intelligentinvestor.com.au.

Read more: http://www.smh.com.au/business/how-low-can-the-aussie-dollar-go-20130624-2osff.html#ixzz2XB3rOnK3

There is no intrinsic value of gold or other commodities. They are inert, non-earning assets.

There is no intrinsic value of gold or other commodities. They are inert, non-earning assets. 

• As an investment, gold is a pure speculation because there is no internal creation of value. 
• Industrial metals, such as copper, are less speculative than precious metals because their prices more generally reflect demand and supply. 

Nevertheless, extrinsic factors operating through buyers and sellers determine the price of every commodity. 


In contrast, for equities and other claims on assets, their value is intrinsic because it is generated by the underlying operating enterprise in the form of earnings, dividends, and cash flows. 


There are no intrinsic prices, only intrinsic values.


http://www.numeraire.com/value.htm

What Warren Buffett says about Commodity Companies

COMMODITY COMPANIES

Warren Buffett does not like to invest in what he calls commodity companies - companies whose product does not differ from that of competitors in any significant way.

A company like this can be vulnerable to the actions of competitors and have limited power to raise prices to retain their profit position in the light of inflation.

WHAT WARREN BUFFETT SAYS ABOUT COMMODITY COMPANIES

Warren Buffett said this in 1982:

‘[Where] costs and prices are determined by full-bore competition, there is more than ample capacity, and the buyer cares little about whose product or distribution services he uses, industry economics are almost certain to be unexciting. They may well be disastrous.’

Copper reaches 2-year high, then dips

October 15, 2010 - 7:10AM

Copper touched its highest in more than two years on Thursday, underpinned by a softer dollar and expectations of renewed demand from emerging markets, but it dipped as pausing equity markets helped temper gains.

Benchmark copper eased back from a 27-month peak of $US8490 a tonne to close at $US8400 a tonne, versus Wednesday's close of $US8362 a tonne.

"Metals track equities... and given the rally we've had over the last few weeks, it wouldn't be a surprise if metals paused for breath at the moment," Societe Generale analyst David Wilson said.
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"But I still think there is enough momentum to still see new highs."

European shares slipped while US stocks were little changed on Thursday.

Copper has rallied by around 40 per cent since hitting a low in June and is only about $US500 away from an all-time high of $US8940 a tonne struck in July 2008.

The talk of quantitative easing in the United States to give a boost to the world's largest economy has been knocking down the dollar and benefiting commodities. On Thursday the dollar's tumble against a basket of currencies sparked a rally across major commodities such as gold and base metals.

"The (softer) dollar is massively supportive and it's expected to continue to weaken through the first half of the next year, and that will remain a supportive factor," Wilson said.

Fundamentally the market remains tight for metals such as copper and tin with miners struggling to keep up with demand from developing markets in particular.

"Emerging markets have been proven to be more than capable of being the locomotive when it comes from commodity demand," said David Thurtell of Citi.

"People are wondering why copper is above $US8000 when the US, UK, Europe, Japan are still in a hole, but the bigger picture is a pretty strong emerging market."

China, the world's top consumer of base metals, will release its third quarter and September economic indicators next week, which are expected to show growth continues at a robust pace of 9.5 per cent.

US data showed rising food and energy prices pushed inflation at the wholesale level up twice as fast as expected last month. Initial jobless claims rose to a higher than expected 462,000 last week.

Tin continues to print historic highs amid dwindling supply from the world's top exporter Indonesia due to heavy rains that have disrupted production and dwindling grades of ore.

"The production problems in Indonesia, the world's second largest producer and largest exporter of tin, are increasing," Commerzbank said in a note.

Indonesia's state miner PT Timah Tbk accounted for over 40 per cent of Indonesia's total tin production last year, it said.

"The company has... stopped its tin sales on the spot market for now and is currently trying to negotiate new supply contracts with its long-term customers. This should mean further headroom for tin prices in the near term, despite the new record high of over $US27,000 a tonne," Commerzbank said.

The latest LME data showed that tin stocks held in LME-bonded warehouses rose by 135 tonnes net today, but they remain close to their lowest in almost one and a half years.

Three month tin closed at $US26,950 per tonne, having printed a new high of $US27,338.50 earlier.

Energy-intensive metal aluminium hit its highest since April at $US2459 per tonne before closing at $US2410 per tonne versus $US2417 on Wednesday's close.

Zinc, used in galvanising, closed at $US2415 per tonne, against a $US2410 close on Wednesday, having rallied to $US2444 also its highest in nearly six months earlier.

Sister metal lead was untraded at the close but bid at $US2411 versus $US2435 per tonne at Wednesday's close. It printed its highest since January at $US2473 earlier.

Nickel, used in stainless steel, closed at $US24,305 per tonne against a $US24,400 close on Wednesday.

Reuters

'We are going to have higher prices for commodities'

'We are going to have higher prices for commodities'
Wheat, sugar, cotton and gold are arousing interest from investors across the globe.


By Paul Farrow, Personal Finance Editor
Published: 7:00AM BST 02 Oct 2010


Sugar prices are at a seven-month high

It wasn't so long ago that investors were extolling the virtues of hedge funds, private equity, currency swaps and infrastructure. But these newfangled alternatives have been knocked off their perch by investments that were being traded by City gents wearing tails and top hats more than a century ago.

Wheat, sugar, cotton and perhaps the oldest of all investments, gold, are grabbing the headlines and generating interest from sophisticated investors across the globe. The reason is rising prices. This week, sugar climbed to a seven-month high on concern that adverse weather will curb output in Brazil, the world's biggest exporter, and Australia, the third-largest.

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Cotton extended its rally to its highest price in more than 15 years, wheat prices have risen by 60pc over the past 12 months, while gold continues to attract investors worried about a global double-dip recession and its price hovers around a record high of $1,300 an ounce.

For many private investors investing in commodities is a novelty. Yet research published this week by JP Morgan suggests that people who do not have any exposure to commodities within their investment portfolios could be missing a trick or two.

"Commodities are the oldest asset class known to man, but perhaps one of the least understood today," said Rumi Masih, the global head of the strategic investment advisory group at JPM. "You can go back even further – one of the first investors known to profit from a commodity trade was the pre-Socratic Greek philosopher Thales (pictured), who, as Aristotle recalls, invested in oil presses near the ancient Ionian cities of Chios and Miletus early in the growing season one year and thus reaped the benefits of a bumper crop of olives."

Mr Masih's research found that commodities were a hedge against rising inflation and improved returns while reducing volatility. Commodities outperformed equities and bonds when economies were in a late expansion phase by 10pc and marginally outperformed when economies were in the early expansion phase just after a recession. The only time they lagged other assets was towards the end of a recession.

The commodity recovery story has been triggered by the supply and demand effect – quite simply, demand for many commodities outstrips supply as giant economies such as India and China march forward.

Even though the demand for metals has been rising, supply is tight – no new mine shafts have been opened in 20 years worldwide, according to JPM. The last iron ore smelter to be built in the United States dates back to 1969.

"The case for including commodities as one component of a diversified portfolio has become stronger in the wake of the 2008 financial crisis and amid the economic ascendancy of China," Mr Masih said. "There are significant supply constraints on commodities amid burgeoning demand for them, not only among developed nations and China but also from a broader swath of the developing world. This includes emerging economies in places as far afield as Africa, Asia and South America."

JP Morgan is not the only commodity bull. Commodity analysts at Standard Chartered estimate that nearly $200bn (£130bn) worth of investment projects were suspended as a result of the financial crisis in iron ore, copper, and coal alone.

Among soft commodities, particularly grains, disruptions to climatic patterns have again tightened supply. "This combination of medium-term demand-side pressure against the background of a limited short-term supply response in many commodities looks set to keep commodity prices supported," said Philip Poole, the global head of macro and investment strategy at HSBC Global Asset Management.

The question for investors is which commodities to buy and whether they are arriving too late to the party – as the graphs show that commodities have recovered from their 2008 falls. Commodities are volatile beasts – just ask investors who piled into oil stocks as crude marched towards $147 a barrel in 2008, only to come down with a jolt as the price plummeted to $60. Investors who bought exchange-traded funds following sugar, natural gas, zinc, cocoa and lead prices have seen the value of their investments fall by 10pc or more.

Gold continues to win favour and, with the economic uncertainty set to linger, demand will be strong. The question is whether the price can go much higher. There are concerns that cotton may not be rich pickings. Connor Noonan, a commodities analyst at asset management house Castlestone, is bullish on the prospects for cotton over the medium term, but he expects a lot of volatility, "with prices easing over the next month".

Evercore Pan Asset invests in commodity ETFs, but at present owns only two – ETF Securities Agriculture and iShares Timber. And it avoids gold. "We sold out of a general, 'hard' commodity ETF, which was a play on oil earlier in the year," said Christopher Aldous, the chief executive. "We have no way of understanding its movement. Its prices seem to be driven by speculators and we have missed out on the price rises – and we are not going to start chasing it now."

Legendary investor Jim Rogers, who set up one of the world's first hedge funds with George Soros in the Seventies, is also an advocate of commodities over the long term – although he warns investors not to simply buy those that have shot up in price in recent months. He recommends commodities that have not moved up that much. "Buy silver rather than gold, for instance, if you want to buy precious metal," he said. "I would like to buy coffee too. But there is still a huge potential [in general]. If governments are going to continue to print money, we are going to have higher prices for commodities."

http://www.telegraph.co.uk/finance/personalfinance/8036344/We-are-going-to-have-higher-prices-for-commodities.html

Hard choices as China's boom fades

Hard choices as China's boom fades
July 13, 2010

Australia's export prices remain about as good as they have been in a century, but the peak is now behind us. What we have seen in the past few years is as good as it will get.

Last week alone iron ore spot prices fell 9.4 per cent and Brazil-China freight prices fell 20 per cent. China's trade figures showed iron ore imports fell 14 per cent last month, measured year-on-year, after rising an average 8.4 per cent each month until May.

Given that China bought 70 per cent of the world's iron ore exports last year, and Australia's iron ore exports this year will be worth about $US50 billion, it is not hard to see that the huge Chinese tail wind for Australia's national income is no longer blowing like it was.

The underlying reason for Australia's once-in-a century resources boom was that China's heavy industry sector has been growing much faster than its overall economy. The boom was inflated by distortions in the economy linked to China's hybrid market-authoritarian form of government.

Now a series of command-economy edicts has flipped this pattern around. Steel production has been falling in absolute terms for two months and the rate of decline accelerated through June. That was despite a surge in exports as mills pocketed export rebates before they are scrapped today.

Over the coming decade the trend in Chinese resource consumption - and therefore Australian national income - will be determined partly by consumer and investor preferences. But the aggregate of those private choices will be trammelled by policy and political choices that the Chinese leadership will either face or evade.

Many of those challenges will be outlined tomorrow at the Australian National University's China Update conference. Zhongxiang Zhang will look at China's efforts to reduce fossil fuel consumption, and its equally serious challenges. Last year China installed more wind power turbines than any other nation. And yet, in the first quarter of this year, 60 per cent of wind power generation capacity was wasted because it was not hooked up to the grid.

Huang Yiping will look at the price distortions that fed China's heavy industry boom, including cheap industrial land, cheap energy and cheap capital.

Huw McKay and Ligang Song will calculate how China's per capita steel consumption could peak earlier and at a higher rate than previously assumed - at double the present rate of consumption in little over a decade.

However, for my money these policy debates will be swamped in coming years by the core question of whether and how a one-party state can make itself accountable.

Over-construction will continue so long as officials receive great financial incentives and few political and legal disincentives against bribery and stealing land. State-dominated heavy industry will continue to over-produce so long as the services sector is stunted by politically powerful state monopolies.

That is why Yongsheng Zhang, at the State Council's Development Research Centre, will tomorrow tackle the question of whether local officials can ever be held accountable to their people when they are appointed from above.

And Yang Yao, the director of Peking University's China Centre for Economic Research, goes even more directly to the heart of things. He writes that the key to China's reform-era success is that the party did not allow policy to be hijacked by special interest groups at the expense of other sectors of the population. But that is now changing, as cadres meld seamlessly into the world of crony capitalism.

''While the private business community is realising the importance of cultivating the government for larger profits, it is the government itself, its cronies and government controlled [state owned enterprises] that are quickly forming strong and exclusive interest groups,'' he writes.

''All this suggests that some form of explicit political transition will be necessary to counterbalance the formation of strong and exclusive interest groups. The Chinese Communist Party must soon realise that there is no alternative to fuller democratisation if it wishes to maintain both high economic growth and enhance social stability.''

Volatilities in other markets when the DOW plunged almost 1000 points

Offshore overnight

In one of the most dizzying half-hours in stock market history, the Dow Jones industrial average plunged almost 1000 points amid worries about European debt.

The Dow managed to recover two-thirds of its losses before the end of Thursday's Wall Street session, but all major indices closed sharply lower on a day that recalled the market turmoil of the 2008 financial crisis.

There were reports that a technical glitch hastened the selling.

Even so emotions ran high, with traders concerned that Greece's economic problems will hurt other European countries and ultimately, the US recovery.

Only 173 stocks rose on the New York Stock Exchange while 3002 fell.

Volume came to an extremely heavy 2.57 billion shares.

When markets settled, the Dow Jones Industrial Average had fallen 347.80 points, or 3.20 per cent, to 10,520.32 points.

The Standard & Poor's 500 index closed down 37.72 points, or 3.24 per cent, at 1128.15 points.

The Nasdaq composite closed down 82.65 points, or 3.44 per cent, at 2319.64 points.

European stock markets lost ground on Thursday as remarks on the Greek crisis by the head of the European Central Bank failed to reassure anxious investors.

ECB head Jean-Claude Trichet ruled out a Greek debt default and insisted that the problems besetting Greece were different from those faced by Spain and Portugal.

The London FTSE 100 closed down 80.94 points, or 1.52 per cent at 5260.99 points.

The German DAX 30 closed down 50.19 points, or 0.84 per cent, at 5908.26 points.

The French CAC 40 index closed down 79.92 points, or 2.20 per cent, at 3,556.11 points.

Commodities

Oil prices dropped to levels not seen since February on Thursday, as the stock market posted huge losses.

The benchmark crude oil for June delivery contract fell $US2.86 to settle at $US77.11 a barrel on the New York Mercantile Exchange.

Oil hit $US73.71 on February 16 and has lost almost $US10 a barrel since Monday.

Crude was lower at noon and the price slide picked up speed as the stock market tumbled and Investors flew to safer havens in gold and bonds.

Europe's debt problems got much of the blame for the drop in stocks and commodities. The ongoing crisis also has undermined the euro and strengthened the US dollar.

Commodities priced in US dollars, such as oil, become more expensive for investors holding euros as the US dollar rises.

In London, Brent crude gave up $US2.78 to settle at $US79.83 on the ICE futures exchange.

Gold for June delivery rose $US22.30 to settle at $US1197.30 an ounce on the Comex division of the New York Mercantile Exchange.

Silver for July delivery fell 1.9 US cents to settle at $US17.515 per fine ounce.

Copper for July delivery settled down 3.45 US cents at $US3.1170 per pound.

AAP, with Chris Zappone BusinessDay

http://www.smh.com.au/business/markets/stocks-set-to-plunge-after-us-freefall-20100507-uhc0.html

Jim Rogers predicts that commodities boom could last 20 years

Jim Rogers predicts that commodities boom could last 20 years
Jim Rogers, the bullish commodities investor, has predicted that demand for raw materials will outstrip supply for the next two decades, fuelling an extended boom.

By Rowena Mason
Published: 11:07PM BST 08 Oct 2009


Jim Rogers predicts that commodities boom could last 20 years. The chairman of Rogers Holdings, based in Singapore, believes the weakness of the dollar will underpin a flight towards commodities.

"I don't see any adequate supply situation in any commodity market over the next decade or two," he said. "The commodities boom is not over and the bull market has several years to go.


"Commodities are the best place to be, if you ask me, based on supply and demand."

Oil could reach between $150 and $200 per barrel, as known reserves begin to decline.

Mr Rogers believes that "unless something happens", crude oil will run out in 15 to 20 years. Although plenty of large oil discoveries have been made lately, the commodity is increasingly hard to extract from the ground.

"The supply of everything continues to decline," Mr Rogers said.

"If the world economy recovers, commodities will do the best, because supply is being restricted. If the world economy does not recover, commodities will still be the best place to be, because governments are printing huge amounts of money."

Mr Rogers, the author of Adventure Capitalist and Investment Biker, said he has not invested in equities apart from in China for the last two years.

He first staked his reputation on announcing the start of a global commodities rally in 1999. The cost of raw materials has risen around 36pc over the last decade.

His comments came as Alcoa, the US aluminium producer, posted surprise profits, boosting mining stock on both the New York and London exchanges.

The company forecast an 11pc increase in demand during the second half, almost entirely fuelled by China.

Global stockpiles of commodities monitored by the London Metal Exchange have surged this year on lower industrial demand during the recession, but analysts believe the market may now be stabilising.

Oil prices broke the $70 mark in the US, rising $2.12 to $71.69 a barrel, while Brent crude climbed $2.50 to $70.54 in London, supported by the weak dollar.

http://www.telegraph.co.uk/finance/newsbysector/industry/6276453/Jim-Rogers-predicts-that-commodities-boom-could-last-20-years.html

Warning: Watch out for US dollar exposure in commodities trading

One word of warning on commodities. Since they are usually priced in US dollars, price moves can sometimes have more to do with dollar strength or weakness than with commodities.

In periods of dollar weakness, for example, commodity prices may rise just to keep their European and Japanese price relatively stable.

This is always an important consideration if you do not want to accidentally speculate on currencies.


Related posts:
Buying commodities. When?
Trade in a basket of commodities
CRB Index
Long periods of high growth and high inflation are rare
The recent commodity story has been all about China
Warning: Watch out for US dollar exposure in commodities trading

The recent commodity story has been all about China

A new period has emerged over the last few years. Growing economies, particularly China, have experienced strong growth and inflation simultaneously. They have tolerated inflation, and let growth rage on. Commodities have had a renaissance. There has been debate about whether China will try to cool inflation, but in the meantime, commodity prices have soared as the hungry dragon searches the world for raw materials.

----

For instance, you could have bought Australian dollars in 2003 as a kind of commodity play.

• The widespread view then was that Chinese demand for commodities would drive prices higher, and that Australia was well placed to benefit as a supplier.
• There were other things in favour of the Aussie dollar, such as strong growth and relatively high interest rates, which gave added confidence.

You would have done well during this perid, given the usual lacklustre environment for trading in commodities.


Related posts:
Buying commodities. When?
Trade in a basket of commodities
CRB Index
Long periods of high growth and high inflation are rare
The recent commodity story has been all about China
Warning: Watch out for US dollar exposure in commodities trading

Long periods of high growth and high inflation are rare

To invest into commodities, you can choose to buy:

• individual commodity
• existing commodity index (basketo of several commodities)
• companies, such as steel or oil companies, which will benefit from higher prices of their products, or,
• the currencies of countries which have a lot of natural resources

The best time to do so is when inflation and economic growth are both strong.

In practice, though, there have not been many periods where growth and inflation are able to rise at the same time.

• Authorities normally respond to higher inflation by raising interest rates. They only have difficulty keeping a lid on inflation if raising rates weakens the economy too much.
• When there is strong growth, the authorities have a lot of room to move without causing a recession, and so they are able to stamp down on the inflation if necessary.
• Therefore, it has been rare to find long periods of high growth and high inflation.
• (This helps to explain why commodities have seen a 50 year or so price decline in real terms.)

CRB Index since 1950:

In the 1970s:

• there was high inflation, largely caused by OPEC, without strong economic growth.
• Commodities has their best run for a long time but prices still barely rose in real terms, because inflation caused a tripling of average price levels.

In the 1980s and 1990s:

• saw the opposite experience, with falling inflation and many periods of good growth.
• This was miserable for commodity prices in real terms. The economic growth was not enough.
• The increased demand by the growing world economy was generally offset by falls in the costs of production and extraction due to dramatic improvements in technology.
• Technology also helped economies reduce their dependence on the more expensive commodities, such as oil.
• Social changes also reduced the growth in demand for commodities, as economies became more service oriented, and less reliant on manufacturing.

Related posts:
Buying commodities. When?
Trade in a basket of commodities
CRB Index
Long periods of high growth and high inflation are rare
The recent commodity story has been all about China
Warning: Watch out for US dollar exposure in commodities trading

CRB Index

While you can choose your own selection of commodities, it is probably easier to use an existing index. The most watched indicator index is known as the CRB index.

Future and options on the CRB index are traded on the New York Board of Trade. It is made up of different categories of commodities:

• Energy: crude oil, heating oil, natural gas
• Grains: corn, soybean, wheat
• Industrials: cotton, copper
• Livestock: cattle, hogs
• Precious metals: gold, platinum, silver
• Softs: cocoa, coffee, orange juice, sugar

Because it covers such a diverse range of materials, its movements will mask moves in the individual components, and smooth out the supply problems. Obviously, there are many other commodities which are not included int he CRB index.


Alternative methods

As an alternative to trading an index on an exchange, there are a number of different ways to trade commodities - apart from keeping silos full of corn in your backyard.

• You can also invest in companies, such as steel companies or oil companies, which you feel will benefit from higher prices of their products.
• Or you can even go a step bigger, and buy into the currencies of countries which have a lot of natural resources.

Related posts:
Buying commodities. When?
Trade in a basket of commodities
CRB Index
Long periods of high growth and high inflation are rare
The recent commodity story has been all about China
Warning: Watch out for US dollar exposure in commodities trading

Trade in a basket of commodities

The strategy to adopt will probably be to trade a basket of several commodities, rather than any specific item. This is because to get the net effect of growth and inflation, you will need to remove a lot of the randomness in the price caused by supply factors.

These supply driven commodity markets can present extra difficulties. These markets are often turbulent.

• They can be influenced by events in remote countries, many of which can be unstable and corrupt.
• They can also be influenced by the random effects of the weather. You don't want your view that higher inflation will cause higher commodity prices to be upset by good weather causing a bumper crop in bananas.

Most of the information driving commodities can be quite obscure. It is a difficult task for investors to somehow get hold of that information. So by trading a basket of commodities, you will win some and lose some on the individual items, and allow the economic fundamentals to dominate. You would rather do that than bet on whether there will be a bad season in an unpronounceable country.


Related posts:
Buying commodities. When?
Trade in a basket of commodities
CRB Index
Long periods of high growth and high inflation are rare
The recent commodity story has been all about China
Warning: Watch out for US dollar exposure in commodities trading

Buying commodities. When?

Buying commodities when inflation and economic growth are both strong

Commodities are raw materials. Economic growths is good for commodity prices because a growing economy needs more inputs. Inflation is also good for commodity prices because commodities are tangible assets rising in price as the value of paper money declines.

Like all markets, the commodity markets have some large moves driven by a consensus on the fundamentals, which drive the price further than generally expected. So the idea here is to identify those periods where growth and inflation are strong, and then to take a long term view with a trading position.


Related posts:
Buying commodities. When?
Trade in a basket of commodities
CRB Index
Long periods of high growth and high inflation are rare
The recent commodity story has been all about China
Warning: Watch out for US dollar exposure in commodities trading