Why you Should Watch Commodities Very Carefully

If you are an investor, commodities may represent an excellent investment opportunity. While equities almost universally suffer from frothy valuations, commodities have only recently begun a recovery from cyclical lows, and there appears to be considerable runway for further growth. Many commodity experts are now talking about a “great rotation” from high-priced equities and bonds into commodities.

If you are an economist, or trying to understand economic trends, you will know there is a raging debate about whether inflationary or deflationary forces will prevail. Commodity inflation plays into the inflationist camp, and by studying what’s happening with commodities, you will have pretty powerful evidence of how inflation is creeping into the supply chain.

Commodities as an Investment

The majority of asset classes are overvalued, including most equities and bonds. Commodities, however, reached a cyclical low relative to equities in 2020. The picture is more nuanced if one looks at individual commodities and it also pays to understand the supply and demand relationships; there is a story behind each commodity.

For example, uranium was booming until Japan’s Fukushima meltdown in 2011, after which the bottom fell out of the market. Many reactors were shut down or mothballed. From a peak price over USD 130/lb in 2007, uranium dropped into the teens, in a market where it takes at least USD 50-60/lb to bring new capacity onto the market.

Many uranium mines, including some of the largest, shut down. For more than a decade, the industry used up massive amounts of inventory, which are expected to run out within a few years.

The United States, Europe and China have each set aggressive carbon neutrality objectives, where nuclear plays a significant role, particularly in China where more than 200 reactors are either in planning or development stage. The price of uranium is still circling around USD 30/lb; the price of uranium mines have begun to climb, some with considerable room to run.

Another interesting story is gold. In 1980, when investors were losing confidence, gold reached around USD 20,000/oz (in 2021 dollars) compared to the current price of about USD 1,760, despite having an excellent performance in 2020.

Very few portfolios hold gold, which provides an excellent hedge or diversification. When investors lose confidence in fiat currencies, want to de-risk their portfolios or protect against negative real yields on bonds, they flock to gold. Historical examples of this are seen between 2000 and 2002, when the Nasdaq declined by 78%; between 2000 and 2008, gold and silver mines went up fivefold. Similarly, in 1973-74, the S&P halved, while gold mining stocks went up fivefold, according to Crescat Capital LLC

Apple’s market cap is now approximately triple that of the entire gold and silver mining sector. There is a good chance that a few years from now that ratio will have reversed.

Electric Demand

For the next decade, a big issue in commodities will be how to supply the massive rise in electric vehicles, solar panels, chips, etc. The chart shows the commodity increases required just for electric vehicle batteries:

Vast amounts of investment will be required. It will be an incredibly exciting and volatile time for investors.

Many commodities have seen high double digit or low triple digit price increases over the past year or two (for example, lumber up by 250%), which have already begun to feed into supply chains, with farther to run.

Uranium prices, for example, will need to increase from USD 30 to a minimum of USD 50 to bring new supply onto the market. Inflationary pressures may be even larger if the United States and China establish their own supply chains for strategic materials.

Increases in oil and gas prices could become a major contributor to inflation. Over the past few years, low prices depressed capital and exploration drilling. If post-pandemic demand roars back, major energy price increases could be in the offing.

Future price movements of most commodities will depend to a great degree on the recovery and growth of China, by far the largest consumer of commodities in the world. So far, it is the post-pandemic leader among major nations in economic growth.

So next time you read that U.S. Secretary of the Treasury Janet Yellen thinks deflation is a greater danger than inflation, or that the Fed knows how to control inflation, think about it, and watch commodity pricing carefully. Once inflation takes hold, it has historically proven very difficult to put the genie back into the bottle.

Disclaimer: The author owns positions in resource companies. The contents of this article are for information purposes only. Investors should conduct their own due diligence or consult a financial advisor.

Les Nemethy is CEO of Euro-Phoenix Financial Advisers Ltd. (www.europhoenix.com), a Central European corporate finance firm. A former World Banker, he is author of Business Exit Planning (www.businessexitplanningbook.com) and a former president of the American Chamber of Commerce in Hungary.

This article was first published in the Budapest Business Journal print issue of February 26, 2021.