“The global demand for resources is beginning to improve, the Far East is growing again, and over the past years, commodity prices are heading in the right direction – as is to be expected at the start of a global economic boom.”
I could easily have written these words today, but believe it or not the quote is from my book “Resources Rock: How to Invest in and Profit from the Next Global Boom in Natural Resources” (published in 2004).
The current bearish sentiment concerning raw materials reminds me of other great opportunities to get invested in the sector over the course of my lengthy career. A common misunderstanding is that low inventories and high commodity prices are the right time to buy into resources. Information like the following therefore causes investors to shun industrial metals & minerals:
SHFE Copper, Aluminum Stockpiles Rise to Highest in a Decade March 22 (Bloomberg) — Copper and aluminum inventories at the warehouses monitored by the Shanghai Futures Exchange expanded to the highest level in at least a decade, bourse data showed today.
In reality, the opposite is and always has been true. The best time to invest in the sector is when inventories are high and prices are low. Prices today are low and inventories high because a slowdown in the global economy (the Great Recession) dampened demand. The next and far more important leg is a recovering economy and rapidly shrinking inventories. Commodity prices, and the share prices of those companies producing raw materials rise as inventories are depleting.
What will stimulate demand enough to draw down inventory levels?
Funds flowing into the stock market will (with a lag naturally) allow the private sector to raise capital (we’re seeing it already) and spend it. More capital spending, more jobs, income and consumer spending. This process can be quick or it can take a considerable amount of time. Lingering wariness about Europe’s financial difficulties and an enormous U.S. budget deficit continues to have an impact.
For example, the whole point of QE is to stimulate business activity but the banks would still rather hoard cash (see graph of Cash Assets, All Commercial Banks) than lend to or invest in corporate America. Their reticence will wane – their need to earn a decent net interest margin demands it. Putting this cash to work will ignite the multiplier effect and fuel economic growth.
Some strategists argue that the disconnect between commodity prices and the stock market is because of the “slack” in the global economy, and predict the disparity to widen further. This makes no sense at all. The stock market has gotten ahead of itself and I expect that fairly ‘ordinary’ corporate earnings news in the 2nd Quarter will bring the overall market back to sensible levels during the summer months.
Liquidity however will continue to work its way into the economy and commodity prices in the 3rd quarter will start to anticipate a robust global economy – and you’ll want to have plenty of resource stocks in your portfolio before then.