A forgotten asset class rediscovered
For many years, Commodities have languished in obscurity as an asset class. The involvement of private investors was limited to a few treasured gold coins at best. Institutional investors also included gold in their portfolios but the allocated weight was usually negligible.
Since the early 1980s, the prices of most commodities have been continuously declining.
Markets saw the price of gold per troy ounce fall from over USD 800 in the early 1980s, to under USD 300 in the second half of the 1990s. This was sharply contrasted with a spectacular rally in the stock market. The US Dow Jones Index, for example, rose from 1,000 to well over 11,000 points over the same period.
With the start of the new millennium, however, the trends for both asset classes saw a reversal. While shares lost much of their value, the prices of many commodities increased considerably. Driven by population growth and changing consumer patterns, the prices of commodities used for industrial processing, such as aluminium, copper and agricultural products soared to new highs almost every week. Crude oil prices also soared, with a peak in the summer of 2008, when the price per barrel broke the USD 140 mark.
However the outbreak of the global financial and economic crisis, marked the end of the rally in commodity prices, with some commodities prices declining more rapidly than share prices.
Yet, even in these difficult times of global recession and excessive public debt, the interest in commodities did not dry up completely, rather it shifted to other segments. Since the outbreak of the crisis, the global uncertainty has been reflected in the spectacular rally in gold, which broke through the USD 1,800 mark in the summer of 2011. Find a good Home Delivery Gold IRA Company to protect your assets.
The first half of 2013 witnessed a weaker performance of commodity underlyings in comparison to other asset classes. However, there have been significant outflows from investors seeking higher return elsewhere. At the start of the second semester, better-than-expected economic data was no longer negative for equities and commodities. Generally, there seems to be more confidence in risky assets, with investors increasing their exposures to commodities – especially the more cyclical sectors such as base metals or energy. The lower than historical average correlation of commodities with equities also increases their diversification benefits, and if inflation rises, as expected, the appeal of real assets may increase again.
Reasons for the revival
The unexpected resurgence of commodities stems from several different causes, which are, to some extent, conditional upon each other. However in their entirety lead to a fundamentally changed supply and demand situation.
The starting point for any possible explanation is the 20-year commodity bear market. Low and constantly declining prices of commodities made the investments needed to develop new resources or to build new processing plants increasingly less attractive. This is especially true for the second half of the 1990s. Before the ‘dotcom bubble’, it appeared more economically lucrative to invest in virtual Internet worlds and advanced technologies, rather than invest in raw materials from mines, which can involve considerable effort.
Boom in demand from China
This supply shortage was confronted, unexpectedly for many, with a sudden surge in demand from Asia – namely China. Over the past decades, China has not only become one of the leading consumers of raw materials, globally, but has also developed into one of the most important industrial centres in the world.
The end to this trend is not yet in sight. This is perhaps best manifested by global oil consumption figures – according to which China overtook the US, to take the lead in 2009. According to the International Energy Agency, IEA, China has this year consumed energy equivalent to 2.25 billion tonnes of oil – 4 percent more than the US. This figure alone may not be surprising, what is significant, however, is how fast the demand for energy is increasing in China. Only ten years ago China consumed just one third of the volume used in the US.
However, this may only be the beginning – on a per capita basis, China, with a population of 1.3 billion, currently consumes only one fifth of the volume consumed by the US. China however, is not alone – other countries in Asia and Latin America are also growing at a rapid pace and, subsequently, so are their energy consumption levels. According to the US Energy Information Administration annual statistic report, the ranking of the largest oil consumers, India (ranked 4th) and Brazil (ranked 7th) have now advanced into the top 10. Back in the mid-1990s, the two countries ranked in 12th and 13th place respectively.
Led by China’s growth, Asia has taken the lead in many other commodities segments. For example, China’s global consumption in industrial metals, aluminium, lead and zinc, has doubled to around 40 percent over the last five years. The main reason for this is China’s ongoing industrialisation and the associated infrastructure development, with metals being a significant requirement.
However, the industrialisation of China alone does not explain the boom in demand. Other Emerging Markets, such as India, Thailand and Indonesia, have also contributed to this trend. As a result of a rapid growth in population, accompanied by increased prosperity, the demand for raw materials of all types has surged in these countries.