Winners Despite Today’s Rate Hike
The strongest evidence of reincarnation may be the commodity supercycle. Each time one perishes, a new one springs to life.
The newest commodity supercycle just celebrated its first birthday… and this little guy has the power to deliver some sizable investment gains over the next few years.
Here’s the backstory…
No two supercycles are identical. But they all share two distinct traits: In their youth, they produce huge investment gains. And in their advanced years, they produce huge investment losses.
That’s why it’s so important to pay attention to them early on… They grow up so fast.
The previous commodity supercycle lasted 17 years and ended last year. That one was a doozy – both on the upside and on the downside!
Between the start of the cycle in 1999 and its peak in 2008, the Thomson Reuters CRB Commodity Index quadrupled! But from that peak to the cycle low last year, the CRB plummeted 67% – nearly erasing all the gains from the early part of the cycle.
Obviously, without the benefit of hindsight, no one can be absolutely certain that last year’s commodity rally was the birth of a new supercycle. But the devastating commodity bear market of 2008 to 2016 was exactly the sort of event that creates conditions for a new bull market in commodities. Here’s why…
When commodity prices fall, resource companies lose money. As losses mount, companies do whatever they can to preserve cash.
They shut down money-losing operations and halt exploration activity. Both of these money-saving measures reduce production and, therefore, reduce commodity supplies. If low commodity prices persist for a long time, the weakest companies declare bankruptcy and shut down completely, which reduces supplies even more.
Without new exploration, resource properties never become producing mines or oil fields. Instead, they remain big patches of earth that contain metal or hydrocarbons… somewhere… maybe.
As long as commodity prices are low, resource companies won’t spend the capital and years required to find and extract the stuff that might be lying underneath those patches of earth.
This sort of underinvestment in current and future production causes commodity supplies to fall, thereby creating conditions for commodity prices to rise. In other words, the death of one commodity supercycle breathes life into the following supercycle.
And that’s exactly what’s happening now.
The CRB advanced more than 25% between February of last year and January of this year. And many individual commodities gained twice as much. Nickel, zinc, natural gas, sugar, silver and crude oil all soared more than 50% during the year.
That’s the good news. The bad news is that commodities have been trading sideways for several months… and trading lower for several weeks.
But a little perspective may be helpful here…
First, the current correction isn’t as bad as it looks. The CRB has slipped only 5% from its January high, and the energy group is the primary reason why.
Apart from five commodities in the energy group, only three of the other 17 components of the Bloomberg Commodity Index are down for the year.
Second, today’s expected interest rate hike by Janet Yellen’s Federal Reserve is probably more bark than bite. Traditionally, interest rate hikes tend to create a headwind for the commodity sector… and they probably will again in 2017.
But the commodity markets are so much more than the whipping boy of the Fed’s interest rate policy. Supply-demand trends wield a much greater influence over prices than Yellen’s interest rates.
Thanks to a strengthening global economy, global demand for all types of natural resources is on the rise. And yet supplies are not always keeping pace with that demand. As a result, a “supply deficit” has developed in several commodities.
Palladium, platinum, zinc, sugar, cocoa and nickel are just a few of the markets where supplies are falling short of demand. And the supplies of several other commodities are becoming increasingly tight.
Bottom line: After the commodity markets pass through the crucible of a new interest rate hike, they will likely resume responding to the supply-demand trends that have been pushing their prices higher for more than a year.
So let’s play a little game of “What if?”
What if a new commodity supercycle kicked off in January 2016?
What would be the investment potential of this new cycle?
Here are a few plausible scenarios:
- If the CRB Index were to rise from its current level to its all-time high, it would gain 150%.
- If the CRB were to mimic its performance during the bull market of 1999-2008, it would advance 66% after two years, 112% after five years and 300% after nine years.
And let’s not forget that the stock market during this time frame was doing a whole lot of nothing. So the commodity markets were not merely delivering a nice return, but delivering a nice return when nothing else was.
The road ahead in the commodity markets could be very rocky, but it could also be very rewarding.
My advice: Invest in the commodity sector on pullbacks; expect a few bumps along the way.
P.S. In the April issue of Oxford Resource Explorer, Emerging Trends Strategist Matthew Carr will reveal an innovative commodity supercycle play. It’s a little-known exploration and production company that’s seeing triple-digit growth. To ensure you don’t miss the issue, click here.