Industrial Commodities as an Investment Theme

The globally synchronized boom from 2003 to early 2008 led to significant increase in demand for industrial commodities (primarily from Asia). As a result, all major industrial commodities and commodity stocks surged during this period.

However, the financial crisis and the subsequent slowdown in the global economy have resulted in a sharp fall in commodity prices. The same is downtrend is reflected in the CRB commodity index which is still down by 46 per cent at 257 (as on May 28, 2010) after peaking out at 472 in July 2008.

Therefore, before considering industrial commodities as an investment option, it is important to figure out if the July 2008 peak marked the end of a bull run for commodities.

In my opinion, the industrial commodities are still in a long-term bull market. This article discusses the rationale for this conclusion and some of the most attractive investment options in the industrial commodity space.

On looking back at the price trend of industrial commodities, it is observed that commodities were in a bear market from 1980-2000. During this period, there was low investment in the commodity space which led to minimal mining and exploration activity.

This trend reversed with increased demand for commodities coming from China and India (particularly after the year 2000). This is also in accordance with the Kuznets cycle, which is a 20-year emerging market cycle that drives commodity demand. The supply-side shortages as a result of low investment in the sector led to sharp increase in prices for all commodities. This marked the beginning of a new long-term bull market for commodities. During this period, the Dollar also weakened and this factor was also commodity price supportive.

Coming to the present scenario, I would consider the current downside as a correction in the long-term uptrend for commodities which might easily last for another decade, if not more. The most important factor for this bullish rationale is that the growth in Asia (particularly China and India), is far from over and has the potential to drive commodity prices higher.

Also, commodities can be considered to be relatively undervalued when compared to other asset classes. The CRB commodity index was at 182 in the year 2000 after nearly 20 years of bear market. This effectively means that the index has gone up by only 41 per cent in the last 10 years. Therefore, one can expect a meaningful upside in commodity prices as investors hunt for relatively cheaper assets.

Besides these factors, a weak currency is commodity price supportive and it is very likely that all major currencies would remain weak against hard assets in the near future as governments keep interest rates low in order to support the economy.

When it comes to specific commodity picks for investment, I would rate copper as the most attractive investment opportunity among the industrial commodities. It is estimated that in order to satisfy global demand, the world needs to mine as much copper in the next 25 years as mined throughout history. This in itself speaks volumes about the potential demand for copper in the long-term and its positive implications on price.

It is also estimated that an average family home uses about 440 pounds of copper. Therefore, as urbanization gains pace in India and continues to increase in China, the demand for copper will remain robust.

Another industrial commodity that has fallen significantly after the crisis and looks interesting is aluminium. The primary growth drivers for aluminium would be China and India’s investment in building, automotive, construction and power industry.

Besides these two commodities, zinc and lead also can trend higher in the long-term with the Asian growth. Soaring car and bike sales in China and India coupled with application of lead in inverters is expected to keep demand for lead robust. Zinc would also trend higher as long as demand for steel is high (as zinc is coated in steel to prevent corrosion). Infrastructure and real-estate spending will ensure steady growth in demand for steel.

Another way to benefit from higher commodity prices is to invest in currencies, stock markets and real estate of major commodity producing countries in the world. Higher commodity prices would result in increase in standards of living in commodity producing countries and, it is very likely that all asset prices will go up in these regions.

I would like to add a word of caution here for all commodities in the near-term. In my opinion, investors would be better off by not taking fresh exposure to commodity and commodity stocks for now. A very likely slowdown in China will negatively impact commodity prices and that could be used as an entry point for investment.

Another world of caution would be that commodities might be very volatile in the future with artificially low interest rates globally leading to swift movement of money from one asset class to another. However, even in volatility, commodities should trend higher and should give healthy returns to long-term investors.

I would conclude by saying what Jim Rogers always has to say about commodities. If the global economy does well, commodities are bound to do well. However, if the global economy does badly, commodities will still do well as governments will go for quantitative easing, which will flood the system with liquidity and ensure commodities remain at higher levels.

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