Once in an Investment Lifetime Opportunity to Profit in Commodities

  • We are at the bottom in global commodity prices. Only in the depths of the Great Depression and at the end of the dying Bretton Woods Gold Exchange Standard did commodities reach this level of undervaluation relative to equities
  • When commodities are this cheap relative to stocks, returns accruing to commodity investors have been spectacular
    • Had an investor bought the Goldman Sachs Commodity Index in 1970, by 1974 he would have compounded his money at 50% per year
    • From 1970 to 1980 commodities compounded annually in price by 20%
    • If that same investors had bought commodities in 2000, he would have also compounded his money at 20% for the next 10 years
  • Commodities are as cheap as they ever get relative to financial assets and outsized returns await those willing to invest today, but most investors still are not paying attention
  • Believe commodities made their cycle-lows back in February 2016 in a spasm of panic selling before rallying strongly throughout 2016
  • Since January, oil prices have fallen back 20% from their highs while investors have become incredibly bearish – a situation not dissimilar to what happened back in 2001 at the beginning of the last great commodity bull market
    • After making its panic low of $11/bbl back in 1Q99, oil prices rallied strongly (up 230%) over the next 18 months
    • After peaking at $37/bbl in September 2000, prices proceeded to pull back by over 50% in the next 12 months, in a wave of bearishness not unlike today (in retrospect, we know that selling spasm in oil presented investors with an incredible buying opportunity)


  • Let’s turn the clocks back to 1970 to see what the financial landscape looked like as commodities made their bear market lows
    • By 1970, era of the gold standard in the US was rapidly drawing to a close. For 180 years, the USD had been defined by the weight and price of gold. For most of its existence, the USD was fixed such that one ounce of gold cost $20.67 before 1934 and $35 thereafter
    • 1960s saw a huge economic boom stimulated by both Vietnam War as well as the introduction of the Johnson administration’s War on Poverty and Great Society programs
    • With dollar pegged at $35/ounce (price perceived as undervalued), foreign governments began to aggressively exchange their USD for ounces of gold in the mid-1960s
    • Inflationary pressures had been strongly building but since everyone believed the US would continue to honor its $35/ounce exchange privilege to foreign governments, inflationary pressures were slow to spill over into commodity markets
    • In 1971, by judging from the weakness in commodity prices, it is safe to assume they thought the US government would severely contract money supply growth, raise taxes to run budget surpluses, and force the US economy into a severe, deflationary recession
    • Great example of the “anchoring” influence of gold can be seen in the price action of copper during the 1960s. Even though US experienced copper shortages during the 1960s, by 1968, copper prices were still below their 1956 high of 42 cents. Oil prices exhibited similar behavior, even in the face of strong oil demand. Global oil consumption actually grew by 8%/yr between 1965 and 1970. Grain prices followed a similar path
    • Deflationary effect on commodities, brought about by the mistaken assumption that US governments would eventually be forced to significantly tighten both monetary and fiscal conditions to slow the run of gold from the US Treasury, caused commodities to become completely dislocated from their incredibly bullish underlying fundamentals
  • Another very important development that took place in financial markets in the late 1960s
    • A group of approximately 50 high-quality growth stocks (“Nifty Fifty”) were about to become institutional darlings and form the nexus of a stock market mania
    • Nifty Fifty were gripped in a classic market bubble with their P/E approaching 50x
    • By 1979, the mania that developed around commodities prevented investors from seeing huge underlying supply and demand change that had taken place. It was time to get out of commodities and back into stocks which had gone through a devastating bear market
    • The great commodity bear market that stretched from 1980 to 2000 shattered the Club of Rome’s belief that natural resource markets had entered into a period of perpetual shortage. A new dogma was accepted that commodities would be in perpetual surplus
    • Huge investments in global mining and oil and gas projects in the 1970s combined with the introduction of new technologies all contributed to the huge surge in commodity supply throughout 1980s and 1990s
    • Break-up of the Soviet Union also contributed to the collapse of commodity prices
    • This excess supply continued to depress commodity markets throughout the 1990s, and contributed to the widely-held belief by 1999 that commodity prices would never recover
    • As opposed to the late 1960s, the buying opportunity of the late 1990s was caused by a combination of excess supply and rampant bearish investor psychology
    • With oil collapsing to $11/bbl and with copper at real price levels not seen since the Great Depression, it was hard to get bullish in the late 1990s
    • Emergence of a huge new commodity buyer (China), combined with more than a decade of chronic underinvestment, that would cause the next massive commodity bull market to unfold
  • Commodity bear market in the 1960s and early 1970s had occurred alongside an overvalued stock market. In an interesting similarity, the great commodity bear market of the 1990s occurred alongside one of the most over-valued markets in US history that revolved around a full-blown market bubble in technology and internet stocks
  • By the end of 1998, oil plunged to $11/bbl lows while the internet stock market bubble had begun to form. By 1999, oil had quietly slipped to a bull market and by the summer of 2000, the tech/internet bubble had begun to break
    • Just like in 1970, if an investor had chosen to invest in commodities in 1999, the payoff would have been huge. From 1999 to 2010, commodities returned almost six-fold while the stock market returned almost nothing


  • After 6 years of declining commodity prices and nearly 8 years of a rising equity market, commodities today are now priced as cheap relative to stocks as they’ve ever been
  • While it is obvious that commodities are cheap today, the most pressing question facing a commodity investor is what will ultimately make them expensive
  • If removing the anchoring effect of the Gold-Exchange Standard allowed commodity prices to explode in the early 1970s and supply disappointments and strong Chinese demand forced commodity prices higher in the 2000 to 2010 cycle, what forces will drive commodity prices up from their depressed levels in this next cycle?
  • Believe that commodity demand will continue to surprise strongly to the upside. Over the last 17 years, commodity-demand surprises have come primarily from China. These upside surprises are far from over, especially with regards to oil, gas, copper, and agricultural commodities
  • However, a new source of demand is about to emerge that few analysts mention: India
    • Believe that India today is precisely where China was back in the early part of last decade
    • The world has never before had two major countries (each with populations exceeding 1.3 billion) that are simultaneously in the middle (China) and just entering (India) their periods of intense commodity consumption growth
    • With India now joining China and the rest of the South-East Asian countries, we calculate that over 4Bn people have now entered into the middle class – the period where commodity consumption intensity rapidly increases
  • We are now entering into a period of pronounced, prolonged acceleration in global commodity demand
  • Supply disappointments loom in many commodities while the conventional consensus opinion believes that supply will continue to surge
    • Global oil market presents a great example of the discrepancy between consensus belief and reality. For the second year in a row, new conventional oil discoveries have contracted to almost nothing. For the first time ever, we are now shrinking our reserve base of conventional oil
    • Believe US shale revolution will not be exportable to the rest of the world. We have reached a bizarre point in global oil supply. For the next several years, the only source of incremental oil supply growth could very well come from just six counties in West Texas
  • In a strange parallel with both 1970 and 2000, a very richly-valued equity market and a related investment mania are once again taking place at the same time as a great commodity bear market
    • Back in the 1960s and the 1990s, the Fed ran very loose monetary policies and very little of that newly created credit wound up in commodity markets. Both prior periods experienced extreme stock market overvaluation and both periods had distinct market bubbles
    • Over the last 7 years, the Fed has run the loosest monetary policy ever experienced and very little of that money wound up invested in commodity markets
    • With the general stock market priced at 20x earnings and with the intense speculation now taking place in the “FANG” stocks, we have yet another data point suggesting we have replicated the set up to both the 1970 and 2000 experiences
  • Although there is no explicit reason why a commodity bear market bottom should coincide with a speculative stock market top, the fact remains that it happened twice before, and history suggests it’s about to happen again
  • At current levels, an investor has an opportunity to profit in commodities that comes only once in an investment lifetime

Goehring & Rozencwajg Associates 2Q17 Commentary, July 21, 2017

Image Source: Goehring & Rozencwajg Associates, Bloomberg

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