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Grantham: We are running out of everything [ClearOnMoney]
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Grantham: We are running out of everything

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Commentary

Grantham: We are running out of everything

26 Apr 2011 by Jim Fickett.

The human race is beginning to run up against resource limits. Commodities are a good investment for the long term. If and when China stumbles, there will be a major opportunity in the commodities markets.

Jeremy Grantham released his quarterly letter on Monday. It is entitled, Time to Wake Up: Days of Abundant Resources and Falling Prices Are Over Forever (free registration required). As always, I recommend reading the whole thing, as it is both entertaining and informative.

The main thrust of the argument is as follows:

  1. Commodity prices were in a 100-year decline until about 2002, when a major shift occurred and they began to rise
  2. The change is a fundamental one, caused by the world running up against a genuine resource limit
  3. Global cooperation is needed to adjust to this new reality; otherwise the strain on civilization could be disastrous
  4. Commodities are a good investment for the long term
  5. Next year might see a slowdown in the Chinese economy, and perhaps also bumper agricultural yields; if so there could be a fantastic opportunity to buy commodities

I am sympathetic to this point of view. However I am not quite convinced on point 2.

Oil plays a central role in the global economy and, at least in this case, I think the arguments are quite clear that there has, indeed, been a paradigm shift. It is quite likely that we are near the peak in oil production, and the long-term trend is towards higher prices. But for some other commodities the case is less clear.

Take, for example, iron. Grantham argues that the rise in the price of iron ore is so far out of line with the long-term trend that there is only a one in two million chance that the old trend of decreasing prices could still be in force. On the other hand, he also mentions that China is currently consuming about half of global iron ore production. One has to ask the question, then, of whether the one in two million event is not China's extraordinary capital investment program. When the most populous nation on earth takes all of its citizen's savings and spends them on a capital investment program that is historically unprecedented, is that not a very rare event? And is it a surprise that when China builds airports, shopping malls, railways, and whole new cities at a completely unheard of rate, that that uses an unprecedented amount of steel? But surely that capital investment program will collapse (just as it did in Japan before), and China's iron ore demand will be scaled back severely.

This is not to ignore the very powerful argument that exponential growth is eventually in conflict with finite resources. But the timing and extent of the paradigm shift are perhaps not quite so clear as Grantham makes them out to be. The human race will, it is true, eventually run out of iron ore and, with iron as with every other commodity I've looked into, the easy deposits are gone and the miners are having to go after deposits of lower quality, in more inconvenient places. But does that mean the current steeply rising price trend will continue? I doubt it.

I will not argue these points any further here but, just for the record, will state my own position:

  1. Most commodities are, indeed, beginning to run into one resource limit or another – the best deposits already mined, fossil ground water for irrigation being used up, etc.
  2. However China's investment boom, which is clearly not sustainable, has caused a huge, temporary distortion of the commodity markets
  3. To the extent that commodities can be bought at pre-China-boom prices (e.g. natural gas), they are likely to at least keep their value and probably increase
  4. Energy is central to the world economy, and deserves a place in every portfolio

In the end my investment decision is quite close to Grantham's: have some investment in commodities now, so as not to miss the boat. And be prepared for a major opportunity should China stumble.