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Each commodity is different [ClearOnMoney]
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Commentary

Each commodity is different

23 Dec 2012 by Jim Fickett.

I, as well as many others, think commodities are a promising area for long-term investment. And I, as well as many others, have attempted to generalize about commodities as a group. But in fact there is so much difference between commodities one should rarely lump them together. Example 1: while we are running out of some things, gold does not get used up. Example 2: while many commodity prices are historically high, and oil is not too far below its all-time peak, base metals, as a group, show prices near their 100-year average.

In April 2011 Jeremy Grantham published a quarterly letter entitled Time to Wake Up: Days of Abundant Resources and Falling Prices Are Over Forever, in which he argued that,

The prices of all important commodities except oil declined for 100 years until 2002, by an average of 70%. From 2002 until now, this entire decline was erased by a bigger price surge than occurred during World War II.

Statistically, most commodities are now so far away from their former downward trend that it makes it very probable that the old trend has changed – that there is in fact a Paradigm Shift – perhaps the most important economic event since the Industrial Revolution.

There is certainly some truth to this and, for some commodities, notably oil, the easy deposits are largely gone and it is quite clearly getting more expensive to recover what is left.

But lumping all commodities together is a bit like saying the world has too many animals – because the expanding population of humans is squeezing many ecosystems – or saying the world's animals are dying out – because of the many endangered species.

The GMO commodity index analyzed by Grantham includes oil. It also includes gold. We are not running out of gold, because essentially all the gold ever mined throughout history is still around as bars, coins and jewelry. And gold's very long-term price trend is roughly level, with plenty of volatility, rather than displaying a long-term downtrend followed by a recent surge, as Grantham observes for his overall index.

The GMO index also includes uranium, whose price trend has much more to do with the cold war, weapons recycling, and periodic public scares than it has to do with any scarcity – the current low price is mostly a function of Fukushima, but is also driven by the recent development of very rich deposits in Kazakhstan.

My point is that every commodity is different. Yes, we will see more and more scarcity, because some things are, indeed, being used up and the world population is growing. But to invest sensibly in commodities, you really have to understand each one separately.

In the recently mentioned Credit Suisse 2013 Global Outlook there was some interesting information along these lines. It turns out that base metals are near their long-term average prices (adjusted for inflation, of course):

most industrial commodity prices have been essentially stationary in real terms over the past 100 years.

It would seem that for base metals in general, the overall 100-year trend is best described as roughly constant prices with one large anomalous drop in the late twentieth century.

Lumping together base metals also hides disparities. The report's detailed analysis shows that iron ore is near its 100-year average price; copper is about 50% above its long-term average; and aluminum is about 70% below its long-term average price.