``We have had 8-9 periods of forced liquidation over the past 100-150 years wherein everything was liquidated without regard to fundamentals. This is such a period…Historically the things which have come out best on the other side are things where the fundamental have been unimpaired. Commodities are the only thing I know with unimpaired fundamentals…The cyclical demand for commodities may slow, but the secular supply will be badly affected so the commodity bull market will last longer and go further in the end-Jim Rogers, Commodity Bull Market Will Last Longer”
In last week’s A Fear Driven Meltdown, we described how commodities have been pummeled on the account of forcible selling.
As we wrote, ``The meltdown has been focused on the assumption of a dramatic decline of global demand. They seem to forget that with the current credit crisis, many of the planned projects will be put on hold or shelved or cancelled, giving way to constriction of supply. If supply falls far larger than the rate of decline in demand then you end up having lack of supply thus higher prices.”
A report from Danske Bank recently validates our premise (emphasis mine), ``But now another side-effect of the ongoing financial crisis and slide in commodity prices is emerging in the form of an increasingly serious negative impact on the supply of commodities and investment plans. Based on cost estimates from analysts Brook Hunt and the lowest prices we have seen in recent weeks, it would appear that up to 50% of world aluminium production, 30% of world nickel production, 10% of world zinc production and 5% of world copper production are now running at a loss. Since the summer there has been a massive shift in cash flow at metal producers, which have gone from raking in profits to producing at a loss.”
When selling prices of commodities fall below the cost of production, losses will account for reduced supplies and eventually prices will have to readjust higher.
Even farmers are getting squeezed by higher credit cost, declining value of land as collateral, and declining commodity prices, the following excepts from Bloomberg,
``The credit crunch is compounding a profit squeeze for farmers that may curb global harvests and worsen a food crisis for developing countries.
``Global production of wheat, the most-consumed food crop, may drop 4.4 percent next year, said Dan Basse, president of AgResource Co. in Chicago, who has advised farmers, food companies and investors for 29 years. Harvests of corn and soybeans also are likely to fall, Basse said.
``Smaller crops risk reviving prices of farm commodities that sank from records in 2008 after a six-year rally that spurred inflation and sparked riots from Asia to the Caribbean. Futures contracts on the Chicago Board of Trade show wheat will jump 16 percent by the end of 2009, corn will rise 15 percent and soybeans will gain 3 percent…
``The number of hungry around the world is at risk of increasing as the financial crisis cuts investment in agriculture and crops, said Abdolreza Abbassian, secretary of the Intergovernmental Group on Grains at the United Nations Food and Agriculture Organization in Rome. The total increased by 75 million last year to 923 million, the UN estimates.
``In Brazil, the world's third-biggest exporter of corn after the U.S. and Argentina, production may fall more than 20 percent because farmers can't get loans to buy fertilizer, said Enori Barbieri, a National Corn Producers Association vice president. The nation's coffee harvest, the world's largest, may drop 25 percent for the same reason, said Lucio Araujo, commercial director at farmer cooperative Cooxupe, located in Guaxupe….
``Minnetonka, Minnesota-based Cargill and Decatur, Illinois- based Archer Daniels, the world's largest grain processors, are among the crop buyers to halt financing for growers in Brazil, said Eduardo Dahe, who represents the companies as president of the National Association of Fertilizer Distributors…
``In Russia, loan rates for farmers have jumped by half in some cases to more than 20 percent in the past few months, Arkady Zlochevsky, president of the Russian Grain Union, said in an interview earlier this month…
``The value of the collateral farmers use to secure loans -- crops and land -- is diminishing. Lenders are demanding more equity for farm loans used to run operations or acquire land and equipment.”
The contraction in supplies of the base metals and soft or agricultural commodities strongly suggests of an imminent inflection point in the commodity markets.
The high profile market savant Jim Rogers in a recent Bloomberg interview screamed for a buy in Agriculture (see video Jim Rogers: Massive Inflation Ahead, Buy Agriculture!)
And we shouldn’t forget that commodity markets move in secular waves see figure 4.
Figure4: Moneyandmarket.com: Long Term Commodity MovesTo quote Sean Brodrick of Moneyandmarket.com (highlight mine),
``The upswings, or commodities supercycles, can last 20 to 25 years, according to Morgan Stanley’s research. And if the current one follows the pattern, we have many years to go before it plays out. The key drivers are the rapid economic growth in China and infrastructure spending in other large emerging markets.
``The fact is, commodity bull markets can see corrections that will make your head spin.
``Other commodity bull markets in modern history — roughly spanning 1906 to 1923, 1933 to 1955 and 1968 to 1982 — lasted more than twice as long as the current run. They included some sharp corrections before they ran their course, suggesting that the current drop, however sharp, could be temporary.”
So with global central banks collectively running the printing presses on a 24/7 basis into the global financial system plus the severity in the contraction of supply gaining an upper hand vis-à-vis the degree of decline in demand, fundamentals suggest a likely forthcoming inflection point on the commodity markets.
And perhaps a rising commodity markets will reinforce the recovery in global equity markets.
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