Until recently, strategists agreed that rapid economic growth in the emerging economies was good news for everyone. Their stock markets boomed and cheap exports tamed inflation in the west.
The US Federal Reserve was able to reduce interest rates to unusually low levels, to reboot economies after the 2000 to 2003 equity bear market. The resulting supply of credit fuelled a consumer boom which helped every asset price to boom.
But every action has an equal and opposite reaction. As a result of economic growth in the past few years, companies and their customers are consuming commodities at a rate that puts the Earth’s resources under strain.
According to a survey produced for Robeco by research group Iris, we have entered an era where there will be an “abundance of scarcity” which could lead to a revolution in investment thinking. High commodity prices have started to fuel costs. The latest data from China suggests that its inflation rate has hit an 11-year high of seven percent.
Inflationary concerns have persuaded the Bank of England and European Central Bank to keep interest rates as high as they dare. Rising prices, illustrated by a rise in the cost of beer to £4 a pint, will lead to higher wage demands in due course.
The Federal Reserve has only cut US rates aggressively, due to the parlous state of the local housing market. Fear of rising inflation has been the result. Increased market volatility is set to become permanent as central banks struggle to contain inflation and prevent recession. The Vix index, which expresses the volatility of the S&P 500, has risen from nearly 10 to 25 over the last 12 months, and touched much higher levels.
Pension schemes with longer-term liabilities will need to consider switching out of bonds.
Seasoned hedge funds, stocks and commodity futures look increasingly attractive. Sector specialist Dawnay Day Quantum has estimated that 10 percent commodity allocations could be justified.
The market jury on the outlook for natural resources is still split.
Some back strategist Jim Rogers in his conviction that commodities prices will move higher. Others back sceptics led by US equity manager Bill Miller of Legg Mason, who reckons commodity booms go as often as they come.
But the argument that the world needs to face up to a sustained rise in commodity prices is starting to gain the upper hand with investors. Data supplied by RCM, the fund management arm of Allianz, shows over-the-counter commodity contracts boasted a sixfold rise in value in the three years to 2007. Investors are net long and commercial producers are net short.
In the latest Barclays Capital Equity Gilt survey, Tim Bond and Nicholas Snowdon take their cue from Thomas Robert Malthus, who argued in the 18th century that physical constraints would put a limit on economic growth.
The theories of Malthus became discredited because he failed to anticipate the volume of the Earth’s resources, and mankind’s use of technology to harvest them effectively.
But Bond and Snowdon argue that Malthusian limits to growth are now within sight. The global population, for example, has risen from 2.5 billion in 1950 to 6.7 billion. It could hit 9.2 billion in 30 years. The Optimum Population Trust, a think-tank, argues that the Earth cannot safely sustain more than 5.1 billion.
Its calculation takes account of the rapid rate at which increasingly prosperous individuals are using up resources. According to the World Bank, individuals in the middle and upper classes increased consumption by more than 200 percent between 1960 and 2004, against 60 percent for those on lower incomes.
Barclays Capital points to the escalating demand for meat, which uses up far more agricultural resources than grain. In 1990, Asia consumed 16.7 kilos of meat per person. By 2002 the total had risen to 27.8 kilos. People in high income economies increased their consumption by eight kilos to 93.5 kilos.
Consumption of every conceivable resource is particularly noteworthy in China. In the decade to 2004, there was a 50 percent increase in its energy demand per capita, which has gone on to escalate further.
African economies are being boosted by the desperate search for resources. Demand for aluminum, corn and soybeans has multiplied several times over. Chinese consumption helps to explain why the lifespan of copper resources has fallen by a third in the 10 years to 2006.
Supply and demand
The International Energy Agency, not renowned for scare-mongering, has suggested that demand for oil could lead to a supply-demand crunch in 10 years if there is a delay to drilling projects.
Barclays Capital says the crunch could happen as early as next year if regions outside the Organisation for Petroleum Exporting Countries fail to meet targets that look increasingly ambitious. Small wonder the price of crude is back up to $100 a barrel.
Investec Asset Management has warned that commodity prices will rise further in the longer term, citing under-investment as well as demand.
Elsewhere, the rapid production of carbon dioxide by fast-growing economies is putting a strain on the climate, with an eventual rise in temperatures of a damaging four to five degrees not impossible. If left unchecked, economic dislocation will result. Bad harvests, such as those which just caused a 25 percent jump in the price of wheat, will become more frequent.
There is even a link between the rising demand for commodities and the credit crunch. When the going was good, consumers benefited from cheap finance supplied by the Federal Reserve to dig the business community out of a hole. Since 2000, the ratio of US household debt to GDP has risen by 67 percent to 98 percent.
Generous terms were offered through operators in the capital markets who overlooked the poor quality of loans in their pursuit of a decent spread. Expansion financed by cheap debt went on to fuel the consumption of commodities across the world.
According to Barclays Capital: “The bubble in credit expansion ended because central banks needed to raise rates to deal with high inflation pressures, most of which had originated in the natural resource market.”
Higher interest rates eroded confidence that asset values, particularly housing, would keep going up and a credit crisis fuelled by mortgage sub-prime lending resulted.
But the momentum behind the consumption of commodities is still in place as Asian economies seek to generate local demand to make good any loss of business caused by recession in the west.
These events represent bad news for bonds and a mixed future for equities, although the latter can perform well in a period of moderate inflation, particularly where dividend yields provide support.
Robeco argues that long-term value is on offer from equities exposed to natural resources, food, water, environmental and health care, where expenditure is not discretionary. Hedge funds capable of profiting from up and down markets are also worth a look.
Commodity futures are likely to gain much greater institutional attention, although consultants tend to be wary of their volatility. Putting money behind an experienced futures trader might be a better bet, although investors who yearn for a quieter life might prefer to opt for agricultural land.