Are Commodities Accommodating?

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According to Barclays Capital, the emerging markets (EM) requirements for the world’s natural resources are growing at such a rapid pace that commodity prices are likely to become a lot more volatile. Amrita Sen, who is a commodities analyst at Barclays Capital, stated her opinion shortly after food prices went through the roof and mining companies all over the world announced good profits due to the growing demand from the EM – especially Asia.

Ms Sen was speaking at a recent event in London which announced BarCap’s 2011 Equity Gilt Study which is a long term study of the returns of financial assets. The analysis shows that demand is so great that technology and production cannot keep up. The report goes on, “The rise of India and China has completely altered the face of the global economy. These economies have accounted for virtually all of the demand growth in the past few years.”

Allan Conway of Schroders and who heads up their EM department said that investors must get used to food crises happening more often and this is down to the growing wealth of the people living in China and India. He carried on, “It is likely to a recurring problem. This is the second food crisis in two years and we will have to get used to this whenever there is bad weather or a bad crop.”

Conway has also noted that the increasing price of staples has been one of the reasons for the recent troubles in the Middle East. Barclays does not disagree, “Resource scarcity is a crucial social, political and economic factor of our era and will likely remain so for the foreseeable future.”

Going back to the Barclay’s report, it is also interesting to note that the links between food and fuel have gone up with fifty percent of the rise in worldwide corn consumption now being used for ethanol production.

This is not the only problem though. Sen believes that with the world wanting more and more commodities it could have serious repercussions for the global economy. Whilst admitting the fact that there was not much individual consumption in China or India these two countries were “driving the commodity market, and in a lot of cases global GDP is being influenced by them.”

Precious metals play an important part in the commodity markets as well. Dr. Marc Faber sees that there could be short term volatility here, especially in gold and silver, but this will only be in the short term. However, he is forecasting the possibility of gold dropping to around USD1,200 or even less but is not worried as the fiscal problems of America and yet more monetization will soon see precious metals soaring again. He does raise the point that if gold does fall to these prices it would be a good time to buy.

Like Sen, Faber is concerned about other commodities as well. He believes they are well overbought. He thinks they are almost at a parabola stage, i.e. going straight up. When this happens there is a chance they will head right back down. Maybe not now but it will happen sometime just as they did in 2008.

According to Faber, this cycle usually happens when higher prices means supply will improve thus giving the potential problem of causing the markets to fall. It must be stated that the cycle for industrial commodities will be longer than that of soft ones as it takes longer for production to materialise. Faber does not care how much money the Fed is printing, he believe this cycle will happen and there will be volatility in commodity markets.

Faber is not a fan of Quantitative Easing as he believes inflation has to happen with more and more money coming into the world. The Fed thinks the best action it can take is to expand the money supply to ease the public debt that stands at four times the size of its economy. Therefore, even with the short term volatility, precious metals are still well worth having in a portfolio.

Faber is not that impressed with T-bills or deposits. He also believes the Fed will try and maintain its interest rate below that of inflation. This is so as to try and avoid the worsening impact from the credit market collapse which expanded to over three times the American GDP. Faber explained, “The US public debt could be much higher if unfunded liabilities like Medicare are included. There are not many options. The US will need to keep printing money for the time being.”

Like Sen and Conway, Faber has worries about the Middle East but puts the reasoning down to oil rather than soft commodities. With the rising demand for black gold in EM and America he thinks there will be geo-political problems for all oil producing countries. Whilst not good for the people of these countries it will help the prices of commodities increase.

The general uncertainty of what is going on worries Faber, “If there is a war, gold and silver would be desirable investments to hold. There will be times like the 1990s until 2008 when gold outperformed stocks and vice versa in 2009. But the key is flexibility. We don’t know how the world will look in 10 years’ time.”

Without doubt, the world’s economies are in for interesting times over the next few months and maybe even years. Like MitonOptimal, Faber believes there will be a short term rebound in the US Dollar but this will not last long. Scott Campbell believes it will not go into Q4. Faber says the value of the Greenback has to go down as the Fed is more than likely to increase its printing of money over and above the USD600 billion which they have already committed to. He says, “Paper [money] will have less and less value with the exception of currencies not printing money, considering what central banks plan to do. Inflation will be an issue in Asia and the Western world. (But) I think governments around the world will increase interest rates sufficiently to combat inflation.”

Finally, Faber is concerned that the slowdown of the Chinese economy may also affect the world economies as it may lead to a reduction in the demand for commodities and so affect the likes of Canada and Eastern Europe.

So, how accommodating are commodities? Well, they should definitely be a part of a portfolio. Depending on how much volatility you are prepared to take will then result in what percentage you decide to invest. In the long term though, with careful nurturing, they will do well for you.

The above data and research was compiled from sources believed to be reliable. However, neither MBMG International Ltd nor its officers can accept any liability for any errors or omissions in the above article nor bear any responsibility for any losses achieved as a result of any actions taken or not taken as a consequence of reading the above article. For more information please contact Graham Macdonald on [email protected]