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Peter Major, portfolio manager, Cadiz
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Time to pull out of commodities
Peter Major, Cadiz
Posted: Mon, 12 Nov 2007

[miningmx.com] -- WHERE are we in the commodity price cycle? This is the second most frequently asked question I receive nowadays. The most frequently asked question is: 'How much higher can commodity prices rise?' Both questions are literally impossible to answer. But we still have to make an effort.

At the very least, we need to take a view on the ranges in which commodity prices will trade in future year as well as establishing where we are in this particular commodity cycle. Fortunately, there are signals and markers that give us an idea however nebulous.

Commodity cycles are called that for a very simple reason. Commodity prices rise and fall within a fairly constrained set of margins, and over time; particularly when one views them in real terms over a period of 40 or more years. One can see the almost 'sine wave' type pattern that usually results.

Granted, the length of these cycles seems to vary widely between the different commodities. Gold seems to have the longest 'sine wave' pattern stretching to periods of over 20 years. While base metals seem to have cycles varying from five to eight years with amazing regularity.

Generally, commodity prices have fairly strong correlations to factors such as the US dollar’s strength or weakness, world GDP growth, inflation, interest rates as well as current supply and demand. And because commodity prices are denominated in US dollars, it stands to reason that a weakening dollar, as seen in the past six years (and through the Seventies and from 1985 to 1991), will trigger gains in the prices of commodities. Therefore, it's as much a matter of calling the dollar and inflation's future path.

A cocktail of the strengthening dollar, with flattening or falling inflation and world GDP growth, will almost certainly bring about a levelling and, most probably, a falling commodity price trend.

But not all commodities are created equal, not by a long way. So before jumping to the conclusion that past price charts and price action can yield future forecasts, let’s back up a bit and define what commodities we are talking about.

My current commodity list - for what it's worth - contains mainly energy and metals and looks something like this.

WORLD SALES pa.

Energy $3.8 trillion (76%)

Base Metals $280bn (6%)

Ferrous $0.84tn (17%)

Precious $95bn (2%)

And this can be subdivided into more individual commodity types. Taking the energy portion of the portfolio for instance:

Oil $2.9tn

Natural Gas $650bn

Coal $300bn

Uranium $9bn

Currently oil and gold are continuing to hit new highs every day. Yet the base metal index has been fairly flat for more than a year now.

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Platinum only recently returned to pass last year's high, while palladium and ruthinium are substantially below their peaks of previous years. And while iron ore (and thus steel prices) show strong signs of further price rises in the year ahead - as does coal - we can only guess where agricultural, uranium and natural gas prices will be in a month’s time, let alone six months, or a year, or three years.

Confusing? Yes. Frustrating? Definitely! And it seems just as hard getting out of a five year massive bull-run commodity cycle as it did ‘getting in’ when commodities had been falling for many years.

The big difference now is that all producers are making buckets of money today whereas six years ago, many were losing money. That was the time to be brave and invest. Now is the time to be afraid and probably disinvest ... which is a scary thought.