Sunday, April 21, 2013

"From Boom to Bust: A Typology of Real Commodity Prices in the Long Run" Plus a Compendium of Dylan Grice at Société Générale, 2009-2012

One of the first persons we quoted on the expected real return from commodities was Dylan Grice, then at Société Générale:
Société Générale's Dylan Grice-"Commodities: ‘Their Expected Long-Run Real Return is 0%’"

Not to be outdone I had to do an intro:
Well duh.
Commodities are for tradin' not investin'.
Which makes one wonder how CalPERS and the other big institutions got snookered by Goldman Sachs into being "Long-Only Index Investors".

Do you, gentle reader, think for one minute that Goldman's crown jewel, Alaron Trading, just buys and socks the stuff away?
Of course not. Alaron makes directional bets, both long and short, to take advantage of the movement.
To a competent trader, volatility is your friend.

In the case of the grains the darn things are mean-reverting.
If wheat doubles in price, the acreage devoted to wheat goes up and prices come down. The substitution effects at the producer level are predictable if not timable:
better net profit for soybeans than corn? Beans it is boys!

In the metals and in energy the more important substitutions are at the user level. If a utility's cost of a BTU is cheaper when gas-fired, the coal orders slow down.
And over-arching everything is the point that Mr. Grice is making. Human beings are adaptable....
In his comments Mr. Grice doesn't use the technical term "Well duh".
And both he and I may have been too disparaging of real commodity price increases which, while definitely not monotonic, appear to have developed over the last sixty years. The patterns of price may be more complicated than I thought.
More below the jump.

From Simon Fraser University:
From Boom to Bust: A Typology of Real Commodity Prices in the Long Run
David S. Jacks
NBER Working Paper No. 18874
March 2013
JEL No. E3,N7,Q30

This paper considers the evidence on real commodity prices over 160 years for 30 commodities representing
7.89 trillion USD worth of production in 2011. In so doing, it suggests and documents a complete
typology of real commodity prices, comprising long-run trends, medium-run cycles, and short-run
boom/bust episodes. The findings of the paper can be summarized as follows: real commodity prices
of both energy and non-energy commodities have been on the rise from 1950 across all weighting
schemes; there is a consistent pattern, in both past and present, of commodity price super-cycles which
entail decades-long positive deviations from these long-run trends with the latest set of super-cycles
likely at their peak; these commodity price super-cycles are punctuated by booms and busts which
are historically pervasive and becoming more exacerbated over time. These last elements of boom
and bust are also found to be particularly bearing in determining real commodity price volatility as
well as potentially bearing in influencing growth in commodity exporting economies.

David S. Jacks
Department of Economics
Simon Fraser University
8888 University Drive
Burnaby, BC V5A 1S6
and NBER

I. Introduction
Once—maybe twice—in every generation, the global economy witnesses a protracted and widespread commodity boom. And in each boom, the common perception is that the world is quickly running out of key materials. The necessary consequence of this demand-induced scarcity is that economic growth must inexorably grind to a halt. While many in the investment community acknowledge this as a possibility, they also suggest that in the meantime serious fortunes are to be made in riding the wave of ever increasing prices.

On the other hand, economists are often quick to counter that such thinking is somehow belied by the long-run history of real commodity prices. Building on an extensive academic and policy literature chartering developments in the price of commodities relative to manufactured goods in particular, this side of the debate argues that the price signals generated in the wake of a global commodity boom are always sufficiently strong to induce a countervailing supply response as formerly dormant exploration and extraction activities take off.
What is missing from this discussion is a consistent body of evidence on real commodity prices and a consistent methodology for characterizing their long-run evolution. To that end, this paper considers the evidence on real commodity prices over 160 years for 30 commodities.

Individually, these series span the entire range of economically meaningful commodities, being drawn from the animal product, energy product, grain, metals, minerals, precious metals, and soft commodity sectors. What is more, they collectively represent 7.89 trillion USD worth of production in 2011. Even accounting for potential double-counting and excluding potentially idiosyncratic sectors like energy, the sample constitutes a meaningful share of global economic activity.

Furthermore, this paper suggests and documents a complete typology of real commodity prices from 1850. This typology argues for real commodity price series as being comprised of long-run trends, medium-run cycles, and short-run boom/bust episodes. As such, there a few key findings of the paper. First, perceptions of the trajectory of real commodity prices over time are vitally influenced by how long a period is being considered and by how particular commodities are weighted when constructing generic commodity price indices. Applying weights drawn from the value of production in 2011, real commodity prices have increased by 252.41% from 1900, 191.77% from 1950, and 46.23% from 1975.

Drilling down even further, extensions of this approach which exclude energy products and precious metals as well as apply equal weights reveal that real commodity prices have collectively been on the rise—albeit sometimes quite modestly—from at least 1950 across all weighting schemes. This suggests that much of the conventional wisdom on long-run trends in real commodity prices may be unduly “pessimistic” about their prospects for future appreciation or unduly swayed by events either in the very distant or very recent past. It also suggests a potentially large, but somewhat underappreciated distinction in between “commodities to be grown” which have evidenced secular declines in real prices versus “commodities in the ground” which have evidenced secular increases in real prices.

Second, there is a consistent pattern of commodity price super-cycles which entail decades-long positive deviations from these long-run trends in both the past and present. In this paper as in others it follows, commodity price super-cycles are thought of as broad-based, medium-run cycles corresponding to upswings in commodity prices of roughly 10 to 35 years. These are demand-driven episodes closely linked to historical episodes of mass industrialization and urbanization which interact with acute capacity constraints in many product categories—in particular, energy, metals, and minerals—in order to generate above-trend real commodity prices for years, if not decades on end. Significantly, this paper finds that fully 15 of our 30
commodities are in the midst of super-cycles, evidencing above-trend real prices starting from 1994 to 1999.

The common origin of these commodity price super-cycles in the late 1990s underlines an important theme of this paper: namely that much of the recent appreciation of real commodity prices simply represents a recovery from their multi-year—and in some instances, multi-decade—nadir around the year 2000. At the same time, the accumulated historical evidence on super-cycles suggests that the current super-cycles are likely at their peak and, thus, nearing the beginning of the end of above-trend real commodity prices in the affected categories.
...MUCH MORE (63 page PDF)
Here are SocGen's Cross Asset Research Team's "Popular Delusions" Reports from 2009 to 2012.
The commodity essays begin on page 142:

Cred and Credulity
A collection of Popular Delusions essays from 2009 to 2012