Jeremy Grantham, the co-founder of global investment firm GMO, is captivated by market bubbles. He has predicted a number of market bubbles during his 40-year investment experience, including the Japanese equities and real estate bubbles of the late 1980s, and the technology bubble of the late 1990s.
It was only last year he made headline news by predicting a housing bubble for the Australian market. However, this time around, Grantham is hard pressed to predict a commodities bubble. Instead, Grantham found a fundamental shift in the market that he says "is the most important economic event since the industrial revolution".
Interviewed in May of this year, Grantham said the days of abundant resources and falling prices are over forever. A month earlier, in a letter to investors, he warned of a permanent shift in the value of natural resources as demand starts to outstrip supply. "The rise in population, the ten-fold increase in wealth in developed countries, and the current explosive growth in developing countries have eaten rapidly into our finite resources," Grantham said at the time.
Grantham says commodity prices will only continue to rise. "Mrs Market is sending us the mother of all price signals. The prices of all-important commodities, except oil, declined for 100 years until 2002 by an average of 70%. From 2002 until now, this entire decline was erased by a bigger price surge than occurred during World War II," Grantham says.
Mining the Opportunities
Grantham says companies who own the "stuff in the ground" offer the best investment opportunities. He has already made investments in forestry and agriculture, though in May he had invested in water as he believes there is something undesirable about owning a resource that should belong to everyone.
Colonial First State Global Asset Management (CFSGAM) is seeing many investment opportunities in quality companies that manage a range of commodities. "We are invested across a broad range of commodities, including precious metals, base metals, bulk commodities and energy products," head of global resources Joanne Warner says.
Warner expects the supply/demand balances of key commodities, including oil, copper, iron ore, thermal coal and coking coal, to remain tight. "This will support prices. However, unlike many of our peers, we do not attempt to forecast short-term commodity prices. Rather, we seek out the best quality companies across a broad range of commodities," Warner says.
In contrast with Grantham’s comments, Russell Investments portfolio manager James Ind says the best way to take advantage of rising commodity prices is to invest in commodities directly, rather than through companies. "Resource stocks tend to be correlated with equity. Investing in commodities directly rather than in commodity equities is going to give you better diversification," Ind says.
Ind warns that investors should avoid being captive to commodity price rallies. "A part of Jeremy's [Grantham] letter to investors was largely missed by the press. It included a very important point, that is, the issue of entry points," Ind says. In the letter, Grantham said investors should not buy commodities at any price. "There has already been a strong rally in agricultural commodities brought on by adverse weather conditions. Furthermore, some of our managers believe the market in the short term is well supplied," Ind says. "Investors need to be cautious about at what point they enter the asset class. There is a danger of a correction given the current price rallies."
CFSGAM's Warner predicts increased merger and acquisition (M&A) activity as a secondary effect of the resource shortages. "High commodity prices have led to the balance sheets of the diversified mining companies improving rapidly over the last 12 months," Warner says. "To better leverage their balance sheet, and to provide short-term growth, many companies are undertaking M&A activity. We have already seen a number of acquisitions in 2011 and we expect this activity to accelerate if commodity prices remain at today's high levels."
Moving Forward
Grantham believes there will be investment opportunities in renewable and alternative energy sources. As companies seek to boost the efficiency of using energy, many will look to adopt large quantities of renewable energy, according to Grantham.
Similarly, CFSGAM's Warner believes alternative energy will play an increasingly important role in meeting the world's future energy challenges. However, she says there are no "silver bullets" when it comes to finding the right alternative energy sources. "While there are numerous alternative--that is, non-carbon based--energy sources available today such as nuclear, solar, wind, wave, geothermal and biofuels, no one energy source today has the potential to single-handedly solve our continually increasing energy needs," she says.
However, Warner says natural gas will play an increasingly important part in world energy demand. "It is abundant and less concentrated in politically risky countries. Natural gas produces 43% fewer carbon emissions than coal for each unit of energy delivered, and 30% fewer emissions than oil," she says.
Some countries are starting to introduce carbon taxes. Australia, for example, the world’s largest exporter of coal, alumina, lead, zinc, mineral sands, beef, wool and sheep, is taking steps to force Australians to use resources efficiently—a move that Grantham supports. Although Australia will be cushioned against rising commodity prices, eventually even down under there will be an imperative to adopt greater energy efficiency and perhaps alternative resources as the country begins to face its own depletion of resources. According to a recent HSBC report, even resource-rich Australia has only 70 years of iron ore, 100 years of black coal, 85 years of bauxite, 65 years of LNG (liquefied natural gas) and 95 years of copper. This challenge will remain for a future generation of investors.
Interviews took place in May 2011.
