A commodity bull market is part and parcel of a new secular inflationary regime, a development few investors alive recall during their professional careers, as the last one ended about forty years ago. Importantly, a new inflation will mark a jarring shift away from the present euphoria in asset markets fuelled by very negative real rates and the most relaxed monetary policy in history.
We think this theme will rapidly come to dominate investors’ attention in 2021, and could last for a decade or more. The key driver is the enduring response to the pandemic, which only accelerated trends in inequality that had been building since the 1980s and the following three decades of globalisation. From here on out, we will see a real macro paradigm shift as the policy focus drifts away from the traditional focus on ensuring financial stability to one that demands social stability above all else.
Financial stability is all about keeping markets liquid and ensuring that the financial system doesn’t seize up and is able to resume credit expansion, while limiting the damage of the last cycle. The policy medicine with every cycle since Greenspan’s rescue of LTCM in 1998 has been a combination of easing of financial conditions with bailouts of existing assets and incumbent wealth, creating a hoped-for “trickle down” effect, or in economist parlance a “wealth effect”. The unwanted side effect has been that each cycle made the rich richer and created a society of the rentier class versus the rest, as well as a yawning inequality gap.
This gap has simply become too vast during the Covid-19 pandemic and while we have seen the same results for the super-wealthy in this cycle as in prior cycles, we are also seeing governments stepping up with unprecedented support for the most vulnerable actors in the economy, as the number one policy priority is now social stability.
Policies that ensure job retention, an attempt at least to prevent smaller businesses from going under, supporting day-to-day living through income support, direct transfer of money via stimulus checks: ultimately much of this looks like varying degrees of a universal basic income (UBI). The response to the 2008-09 crisis saw an initial stimulus splash that was a modest precedent for the Covid-19 crisis but, unlike in that cycle, this time governments will absolutely not return to the brutal austerity regime that quickly set in after 2009, whether in the US (helping in the advent of Trump), in the UK (leading to Brexit), or in Europe (leading to existential strain and a profound depression in much of the periphery). This time, we will see full-blown Keynesian spending - and even beyond anything Keynes ever imagined with proper modern monetary theory (MMT), in which money is printed without any thought of the debt implications, and only inflation tames the heat coming off the printing press.
The social stability paradigm has three main objectives: to reduce inequality (and through it increase demand), the green transformation and the improvement of infrastructure.
The first implication of this shift is that the focus moves more to ensuring minimum income, which results in more stimulus of demand as lower earners tend to save very little of their income. The other source of demand injected by the government will be the green transformation, which is not initially profitable without a huge public subsidy. As well as this, infrastructure investment, partially linked to the green agenda, has suffered badly since the austerity drive after 2008-09. Roads, bridges, electricity and internet infrastructure; the list is endless.
Now for the inflationary part. One important consideration in this big demand push from government and now institutional money is the cost of the physical and commodity inputs required to meet rising consumer demand and the vast planned investments. From food and fuel to industrial metals and exotic minerals and materials, whole swathes of the productive side of our economies are insufficient to meet the new demand, after years of poor returns and underinvestment. In particular, the political will to invest in inefficient green energy will drive a vast rise in energy input prices as we take a stab at finally making real progress in decarbonising the economy.
Electric vehicles have become symbolic of the transformation away from fossil fuels, but interestingly, EVs need in the order of four times more copper than a conventional car. Creating the infrastructure to provision the charging of the cars, not to mention charging them with an energy input into the electric grid that is not coal or natural gas, will use up even more of it.
Even the price of fossil fuels themselves is likely set to rise steeply, as few dare to invest in them anymore, meaning that this most capital-intensive of industries will struggle to ever grow production, with the marginal cost of capital easily in excess of 10-15%. Investment into energy is now less $300 billion a year, down from $900 billion a decade ago, and remember that those $300 billion need to meet an ever-increasing demand for electricity.
In short, the drivers of the commodity bull market will be:
- A lack of supply due to underinvestment, and environmental and climate considerations.
- Increased use of commodities as the green transformation has a much higher use of commodity inputs.
- Government fiscal deficits that will need to stay in place for at least ten years to achieve the stated goal of full employment.
- The rise of India. By 2030 it will have a population of nearly 1.5 billion people, with more than half under the age of 30. That young demographic profile is a huge contrast with China, where the labour force is already shrinking from the legacy of the one-child policy. Between now and 2030, India will take an increasing portion of world resources.
- Negative real interest rates (where inflation is higher than the policy rate). In today’s world many believe that only equity carries any risk premium, but commodities are making a bid to do so as well. As 2021 begins the 28 largest commodities as a basket now sport a positive roll yield, or, in plain English, you are being paid to own commodities. For example, for iron ore, the price difference between the spot price and the January 2022 price as of this writing is in excess of 38% (January 2021 @169 vs. January 2022 @ 122).
- The physical world versus the online/digital world. The pandemic has also created a significant acceleration in purchasing goods online. The demand has been too high for the infrastructure to follow. Shipping rates (for containers) is up 400% and we estimate that last-mile-delivery costs are up 50% on average. There aren’t enough containers, vans, and cars and drivers to keep up with the speed of the transformation. Of course, building this out will only further accelerate investment, which in turn drives higher spending on basic resources like iron ore, steel, cobalt, platinum, palladium, silver, copper and other metals.
2020 was all about the green transformation as an investment theme. That is the narrative. Now, when we need to deliver on those aspirations and projects, the story is the implementation phase, and that means the physical world with all of its limits.
2021 for us is the year where the narrative of a greener, government-supported transformation of the social paradigm meets the reality: too little supply, inadequate infrastructure, and a business world that has been so busy getting digital and virtual that they forgot the real physical world. You can have the world’s best product online and sell millions of it, but if you cannot produce, ship and deliver it, good luck making a return.
Everyone has an interest in improving infrastructure, in more ESG and in the climate agenda. Just as Covid-19 reminded us of how vulnerable our perhaps over-tuned economy is to disruption, 2021 will remind us of how we need to live, act and make money in the real world.