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Commodities Demand – the Contrarian Manifesto.


At a CFA Vancouver presentation last week, Smead Capital Management presented a contrarian viewpoint not often heard these days.

Smead contends that the preeminent driver of the commodities bull market is China where massive construction spending has driven commodities demand and prices to new heights. (No argument there). His manifesto concludes that this is unsustainable (no argument there either) and that this may present a contrarian investment opportunity.

Smead spoke to two charts in particular.

The first chart shows China’s share of total global demand for various commodities groups.

Chart source: http://www.businessinsider.com/facts-chinese-consumption-2011-5#ixaa1QU#ixzz1ZYdOGmyv

While this chart doesn’t differentiate between long-term stable demand and stockpiling, (a key question), the real question is how can the Chinese economy use ~40% of global commodities production and still only produce 9.4% of global GDP? (From and for 19% of global population)?

The second chart shows the rolling ten-year commodity performance. The last 10 years have seen commodities prices approach their statistical zenith as China (and India) have grown (uninterrupted by recessions) for a decade. It’s clear what will happen to commodities prices when China’s investment-driven economy slows. (It has begun and Chinese authorities intend to slow it further in an attempt to curb inflation).

Chart Source: Stifel Nicolaus March 9, 2011 report “World Energy Price, Economic Growth, and the Financial Setting of Agri-Business”

 

If Smead is right, then investors can expect to see more of what markets had to offer in August and September.  Volatility and a sliding Loonie.

Recall an August post that charted the correlation between commodities prices and the Loonie.

Chart Source: http://www.bankofcanada.ca/rates/price-indexes/bcpi/commodity-price-index-annual/  and  http://www.oanda.com/currency/historical-rates/

 

The contrarian investment opportunity, according to Smead, is a re-emerging U.S..

“All this leads us to a transition to the pent-up demand for everything from cars to homes to travel in the wealthiest nation in the world. TheUShas 310 million people who have enormous incomes and still are the largest economic engine in the world. These folks have postponed forming households, buying homes and getting on with their life waiting for this commodity boom and religious belief in emerging markets to come to a miserable conclusion. They have worked hard to get their income statements and balance sheets in order and paid for the banking system to get recapitalized. Commodity prices coming down and investments being repatriated could cause a booming domestic stock market and one of the best eras the US dollar has ever had!”

If investors were looking for a contrarian investment opportunity, look south.

(Just not yet, in my opinion).

Next time?
Risk management.
Doug Cronk CFA is Manager, Investments for a Canadian Pension Plan
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