- May 9, 2011
- Don’t Turn Out the Lights on Commodities Just Yet
The prices for many commodities suffered the worst week in recent memory last week. Oil prices dipped below $100 per barrel, gold fell below $1,500 an ounce and silver gave back much of the past month’s gains by falling to the $35 an ounce level. The prices for other commodities such as sugar, tin, nickel, aluminum, lead and copper also pulled back.
Immediately, headlines on websites such as Marketwatch, Bloomberg and SmartMoney read “Has the Commodity Bubble Popped?” and “Imploding Commodities Complex.”
Is this the end? Has the great bull run for commodities come to an end?
In our opinion, not likely.
First of all, we wrote on April 24 that commodity prices were due for a pullback (Read: Don’t Fear a Pullback in Prices). Specifically, we pointed out that silver had wandered into “extreme” territory which exacerbated the reversal we saw this week.
On May 3 (before we saw the largest declines), BCA Research wrote “one look at the hyperbolic rise in silver prices should be sufficient to convince even a hardcore commodity bull that things are getting frothy.”
In fact, the silver trade had gotten so far ahead of itself, the iShares Silver Trust ETF was “the most highly traded security on the planet,” according to our friend Tom Lydon over at ETF Trends. Last week’s selloff was less of an end to the bull market and more a function of “stampeding speculators” (to borrow a line from Sarah Turner at Marketwatch) rushing for the exits.
But short-term speculators aren’t the only factor; last week’s strength in the U.S. dollar was just as much a facilitator of the price declines. The U.S. dollar found additional strength on Thursday after Jean-Claude Trichet, president of the European Central Bank (ECB), said the ECB would not raise rates until after June. By week’s end, the U.S. dollar was up 2.5 percent for the week, a pretty big move.
In addition, we entered the month of May which has historically proven to be a weak and volatile period for commodities. With the Federal Reserve set to wind down its quantitative easing (QE2) program by the end of next month, it’s possible we could continue to see volatility for a little while.
Despite the selloff, commodities were still the year’s top performing asset class as of Thursday. You can see from the chart that the year-to-date return for commodities has far outpaced the return for foreign exchange, bonds and emerging markets.
Looking out on the horizon, very little has changed for the long-term bull case for commodities. The U.S. is still struggling to come up with a feasible solution to its multi-trillion dollar debt problem. Emerging markets are still seeing incremental increases in demand for nearly all commodities. And, the reserves for many commodities are still struggling to keep pace with this demand.
Essentially, what happened last week was more of a “technical correction” than a fundamental shift in the long-term dynamics for commodities and we’ve already begun this week with big gains for silver and crude oil prices.
The party’s not over for commodities, so don’t turn out the lights just yet. While it’s impossible to predict the future, we think in a month or two investors may look back and see this downdraft as a good buying opportunity.
None of U.S. Global Investors family of funds held any of the securities mentioned in this article as of March 31, 2011.
The Deutsche Bank Liquid Commodities Index (DBLCI) tracks six commodities, rolling positions in crude oil and heating oil monthly, and in gold, aluminum, corn and wheat once per year. The Deutsche Bank Currency Return Index (DBCR) is a foreign exchange index that is designed to capture the long0term systemic returns in currency markets. The DBCR replicated the three most widely employed FX strategies–carry, momentum and valuation.
The DBIQ Global Sovereign suite of indices offers coverage of both the fixed coupon and inflation linked government bond markets. The creation of the DBIQ Global Inflation-Linked Sovereign reflects the growing importance of the inflation-linked market. The suite covers 21 countries with an inception date of 31-Dec-97. The objective of producing a highly liquid and replicable index has been achieved by defining strict and transparent index rules with high liquidity requirements resulting in only the most actively traded debt of each country being captured. Global IG Sovereign reflects the returns of the Global Developed Country Fixed Coupon Government bond market.
Barclays Capital Municipal Bond Index A broad-based, total return index. The Index is comprised of 8,000 actual bonds. The bonds are all investment-grade, fixed-rate, long-term maturities (greater than two years) and are selected from issues larger than $50 million dated since January 1984. Bonds are added to the Index and weighted and updated monthly, with a one-month lag.
The MSCI AC (All Country) Asia ex Japan Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of Asia, excluding Japan. The MSCI AC Asia ex Japan Index consists of the following 10 developed and emerging market country indices: China, Hong Kong, India, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan, and Thailand.
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- April 1, 2011
- The Strong Link Between GDP and Oil Consumption
Global crude oil and liquid fuel consumption grew at its second-fastest pace in over three decades in 2010, rising 2.8 percent to 86.7 million barrels per day, according to the U.S. Energy Information Administration (EIA). In fact, worldwide oil consumption surpassed 2007 pre-recession levels.
For 2011 and 2012, the EIA forecasts that, around the world, we’ll use an annual average of 1.6 million barrels of oil per day. The EIA says this increase is expected to be driven by rising demand from the emerging world, mainly China, Brazil and the Middle East.
While Chinese oil consumption growth is expected to slow from the blistering 13.1 percent growth the country experienced in 2010, China is still expected to see a 6.6 percent growth in consumption this year. By 2015, the International Energy Agency (IEA) estimates that the use of oil in China will increase some 70 percent from 2009 levels, accounting for 42 percent of global demand over that time period.
One key driver of the increase in oil consumption is the continued rise in economic wealth of China and other emerging countries. Historically, the amount of oil consumed per capita is strongly linked with the country’s GDP per capita.
This chart from Barclays compares selected Asian countries’ use of oil over several decades by their population and GDP. You can see that Chinese per capita oil consumption is well behind the pace of its Asian peers when they had a comparable level of GDP per capita.
Currently, China’s GDP per capita is just over $5,000 on a purchasing power parity (PPP) basis. That translates into consumption levels of just over 2 barrels of oil per person, per year. At the same PPP levels, Japan (over 18 barrels per person), Taiwan (about 6 barrels per person) and Korea (just over 4 barrels per person) consumed much larger amounts of oil at a similar level of GDP per capita.
Barclays says that China’s per capita oil consumption would have to increase nine-fold from 2010 levels in order to match that of the U.S. and India’s would have to increase 23 times what it was in 2010. If this were to happen an additional 170 million barrels a day of production would be needed to meet demand.
Considering the U.S. roughly consumes as much oil, in terms of total consumption, as the next five highest oil-consuming countries (China, Japan, India, Russia, Germany) combined and China has over 1.3 billion people, it’s doubtful we’ll see this come to fruition any time soon. However, China only needs to catch up with the likes of South Korea or Taiwan to put a severe strain on global oil supply.
This means that the global oil market will remain tight for the extended future. Barclays says “relative to other sectors of economic activity, oil has become scarce, implying a need to divert ever larger shares of total economic resources into the exploration and recovery of oil.”
Watch Evan Smith discuss ways to play higher energy prices with Margaret Brennan on Bloomberg’s “In Business.”
Purchasing power parity (PPP) is a theory of long-term equilibrium exchange rates based on relative price levels of two countries.
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- March 3, 2011
- Chart of the Week - Oil Shocks
The deteriorating situation in Libya and lingering fears that the uprising will spread to other countries sent oil prices above $100 per barrel on Tuesday. As of March 2, it appeared that 1 million barrels per day (roughly 62 percent of capacity) of Libyan oil production was shut down.
The turmoil has led many to compare today’s events with those of the 1970s and 1980s when the price of oil quadrupled and American drivers waited in miles-long lines to receive their rationing of gasoline. In fact, we’ve already seen the media discuss the possibilities of $200 per barrel oil and $10 gasoline.
While these discussions grab attention, the likelihood of them coming to fruition is slim. This week’s chart from Deutcshe Bank shows the effect of these types of events has waned over the years because today’s global energy market is far different than it was in the past. Deutcshe Bank compared four oil price shocks relating to supply disruptions since the 1970s: The Yom Kippur War in 1973, the Iranian Revolution in 1979, the Iraqi invasion of Iran in 1980 and Iraqi invasion of Kuwait in 1990.
You can see from the chart that the Iraqi invasion of Kuwait in 1990 had roughly 40 percent less of an effect on oil prices than the Yom Kippur War did. Deutsche Bank says this is because the United States and other world powers have become more skilled and better prepared in response to these events.
For starters, the International Energy Agency (IEA) was established in 1974 to “help countries coordinate a collective response to major disruptions in oil supply through the release of emergency oil stocks to the markets.”
In addition, Europe, the U.S., and recently China have built strategic petroleum reserves (SPRs) to insulate themselves from such shocks. The SPRs can be deployed in the event of a severe increase in oil prices which would likely cause a major adverse impact on the national economy.
Western Europe, a top destination for Libyan oil, is most vulnerable to a disruption in the North African oil market but the IEA says that European refiners have an ample amount of crude until the end of March and are currently making arrangements for April. In addition, the IEA says “crude oil markets in Europe are not perceived as constrained, with crude demand relatively low due to a period of large-scale maintenance of refineries.”
The U.S. SPR contains 727 million barrels of oil—enough to cover 75 days of U.S. oil imports.
So far, U.S. consumers have remained resilient in the face of higher gasoline prices. Nationwide gasoline prices have risen 27.6 cents over the past month and are 20 percent higher than a year ago but data from MasterCard released this week shows gasoline demand is up 2.6 percent on a year-over-year basis for roughly the same time period.
Heading into the summer driving season, this resiliency will become even more important if the turmoil should continue.
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- February 24, 2011
- Unrest and its Effect on Oil
We’ve all watched with uncertainty as an uprising in a small North African country more than a month ago has turned into a revolution for the entire region. The turmoil has sent global markets tumbling and oil prices above $100 per barrel for the first time since 2008.
The events are unfolding so quickly that it may be difficult to keep up to speed. I’ve found two good sources which help explain what is going on. The first is from The Wall Street Journal and is an interactive timeline that takes you all the way back to December when the first signs of unrest began in Tunisia. You can also get a country-by-country breakdown of the latest events and key statistics at CNN.com. The breakdown also includes some insightful maps and details on the origins of the uprisings.
Oil has increased because many are expecting delays, if not an extended shutdown, of Libya’s oil production. An Organization of Petroleum Exporting Countries (OPEC) member, Libya is heavily dependent on its oil. The hydrocarbon industry accounted for 95 percent of export earnings and 80 percent of the country’s fiscal revenues in 2008, according to data from the International Monetary Fund and the U.S. Energy Information Administration.
The country produces 1.58 million barrels per day of oil, roughly 2 percent of global oil supply. Most of this oil gets shipped to Western Europe, China and even the U.S. Other countries, such as Algeria, which is Libya’s western neighbor and produces 1.25 million barrels per day, haven’t seen the same degree of protest, as of yet.
Amidst the turmoil and uncertainty, it’s important to remember this is a short-term spike. We expected to see $100 per barrel of oil prices some time this year and the uprising in Libya isn’t going to shut down the world’s oil industry.
If it turns out that Libya’s production is shut down for an extended period of time, the market will eventually adjust. In fact, OPEC is sitting on three times Libya’s daily oil production in excess production capacity, according to Zacks Investment Research.
What is more important for the long-term oil story is the economic recovery. Already in the U.S. gasoline prices have hit seasonal highs. In order for oil prices to maintain these levels, demand must be resilient. As Zacks says “oil spikes have a history of getting in the way of economic stability and growth.”
BCA Research has some interesting data regarding the economic impact of rising oil prices. The firm says that every $10 rise in oil prices translates into a 0.1-0.2 percent reduction in economic growth. This reduction doesn’t mean much when we have a slow rise in prices over an extended period of time, but can become meaningful during a compressed time period.
We expect more volatility in the near term as revolutionary forces overthrow oppressive regimes but our focus remains on the strength of the global economic recovery and its ability to withstand higher gasoline and energy prices.
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- February 14, 2011
- Growing Opportunity in Agriculture
Bushels of corn reached their highest prices in nearly three years this week after the U.S. Department of Agriculture (USDA) reported that corn inventories will fall to levels not seen since 1996.
We’ve witnessed nearly a 100 percent surge in the price of corn over the past year as increased demand has been met with diminishing supply. Dry weather conditions due to La Niña in Argentina and other disruptions have shriveled supply despite a near record amount of acreage being planted. Globally, corn consumption has increased 10 percent over the past five years to reach record levels and stock-to-use ratios for corn suggest we’re currently experiencing the tightest global corn market since the late 1970s, according to Macquarie.
This jump is due to increased corn consumption for ethanol and greater demand for feed grain. The USDA estimates that just under 40 percent of U.S. corn production will be consumed for ethanol, up from 31 percent in 2008-2009. China will likely need to import 5 million tons of corn in 2011 in order to meet the country’s booming need for feed grain. In the U.S., an additional 60 million bushels will be used for feed despite a reduction in livestock, according to the Des Moines Register.
Corn is just one part of the food pyramid that is rising. Around the world, prices for wheat, soybeans, cocoa and other grains have jumped in the last 18 months in conjunction with the global recovery. Prices have jumped because demand outstripped supply.
This chart from Potash Corp. shows that grain production has failed to meet consumption in seven of the past 11 years. This is despite producing a significantly larger amount of grain in 2009 than in 2000. Potash Corp. estimates world grain production declined more than 4 percent in 2010. An extreme drought in Russia chopped grain production in the country by 38 percent and 13 percent in neighboring Ukraine.
These tight supply/demand fundamentals reflect the impact of a growing global population and increasing economic strength in emerging markets, Potash says.
As per capita wealth has grown in other countries, there has been a huge jump in demand for grains. This chart shows the amount of bushels consumed as GDP per capita rises.
Much of the rise is due to people consuming more meat as their fortunes rise. To meet this higher protein diet, more chickens, cows and hogs are fed grains and demand skyrockets. You can see that China and India are still in the very early stages of increased consumption.
We think the agricultural space is ripe with opportunity. With global grain inventories relative to demand at multi-year lows and the rising emerging market middle class showing a healthy appetite for more meat and dairy products, demand for increased crop yields should remain strong.
None of U.S. Global Investors Funds held any of the securities mentioned in this article as of 12/31/10.
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