Monday, May 9, 2011

"What Grantham Got Wrong About Commodities"

Last week I ended a post on Grantham's 'paradigm shift' by saying "You can probably guess that I tend toward the optimistic."
[you started it with  "Remember: A paradigm is only worth twenty cents." uggh -ed]
Here's another view that tends toward the optimistic (lower prices), from Traders Narrative:
A few readers commented that my objections to Jeremy Grantham’s thesis that the days of abundance are forever over didn’t really address the points that he brought up but merely his conclusion.

My objection was that at or near the top of every single major market move, we can find intelligent people who argue that we have said goodbye to the usual cycles of the past and are now embarking on a new period of linearity. If you were around the last equity market top in 1999 and 2000 you won’t have to strain hard to remember the arguments. Who could forget “Dow 36,000″?

Casting back a few more years to the infamous 1920 equity market bubble, we have the infamous words of Yale economist Irving Fisher, who said days before the crash, “Stock prices have reached what looks like a permanently high plateau.” And I’m sure you won’t have any difficulty in coming up with more examples.
While we may scoff at these past arguments with the perfect knowledge that hindsight provides us, at the time they were intelligently sourced and convinced many.

So that provides the biggest caveat emptor whenever we hear the words “it is different this time” or any variations thereof.

Here are three things which Grantham didn’t give their due attention in his long term analysis of commodity markets:

Consequences of China’s Real Estate Bubble
First, the role of Chinaas as a juggernaut in the commodities markets. Grantham does mention China, saying:
The primary cause of this change is not just the accelerated size and growth of China, but also its astonishingly high percentage of capital spending, which is over 50% of GDP, a level never before reached by any economy in history, and by a wide margin. Yes, it was aided and abetted by India and most other emerging countries, but still it is remarkable how large a percentage of some commodities China was taking by 2009. Exhibit 3 shows that among important non-agricultural commodities, China takes a relatively small fraction of the world’s oil, using a little over 10%, which is about in line with its share of GDP (adjusted for purchasing parity). The next lowest is nickel at 36%.The other eight, including cement, coal, and iron ore, rise to around an astonishing 50%! In agricultural commodities,the numbers are more varied and generally lower: 17% of the world’s wheat, 25% of the soybeans (thank Heaven for Brazil!) 28% of the rice, and 46% of the pigs. That’s a lot of pigs!
China’s central bank and government has been able to prolong the inevitable for the past few years. But there is no arguing that their economy is running on fumes. They also have blown one of the largest credit induced real estate bubbles in the history of the world. Just as with previous real estate bubbles, a host of individual mechanisms has convened to push up prices to the breaking point.

Things are so out of control that the Chinese real estate bubble is spilling over into the Vancouver real estate market, pushing price to rent ratios out of whack. The inflow of hot money from Chinese investors is also pricing out domestic demand from Canadians, leaving many double income families without the ability to purchase a home.

So it is surprising that Grantham doesn’t connect the dots and conclude that when China’s real estate bubble implodes, it will take down their economy. That in turn will result in the total price devastation of commodities. The shockwaves would then spread through commodity markets as demand collapses.

Bona-Fide Loophole
The second point Grantham misses is the structural and regulatory changes that have occurred in commodity markets in the past 40 years....MORE
Don't get me wrong, I'd love a one-way bet on higher prices.
It would eventually lead to a chaotic even violent landscape in which I vainly think I would do okay.
[or die trying to defend your rhodium stash -ed]