Tuesday 28 July 2015

Commodities - China plays a blinder, Gen Y are renters.

Back in 2006-7 commodities were on a tear and oil was following not far behind. Speculators were hoovering them up as part of a the next great asset theme that was, like most new asset classes, based on the fact that the price had already gone up so it must be an asset(I wish you add here that foreign exchange is not an asset. A foreign currency can be but being told by your friendly FX salesperson that playing the currency markets is an asset is nonsense). Buying commodities for speculative or investment purposes is a game of storage. The commodities that are on their way from miner to end user are syphoned of into a metaphorical and often physical storage tank and held to be sold at a hopefully a higher price. When the markets turn this tank of speculative holding is off loaded adding to the supply. Rather than smoothing price moves they are exaggerated.  

The love affair with commodities is well and truly over. Many of the largest producers have been through a phase of hand wringing and CEO dumping as avarice induced supply investment has lead to Wiley Coyote moment of self induced collapse. The lags between investment decision and outcome are painful and you only have to look at the Baltic Dry Index to see what a pre-emptive glut in ship production has done to shipping prices. Through all of this I think China has played a stormer. I know that there is a natural tendency to believe that China has little  control over its behemoth economy (Exampled by recent Chinese stock moves) but in the bigger plan I do think they know what they are doing. With commodities they have sucked in Australian commodity producer hubris and spat out the bones. 

If I had a 20 year plan I would have done exactly the same. Allowing the idea of massive future demand to proliferate catalysing investment in new supply at an unprecedented level. At the same time watching speculative demand drive prices even higher adding further justification to the Capex spend. But once greater supply comes on line you then reduce your demand and watch the price of the commodities you ultimately need collapse. The speculative storage tank drains in a panic pushing prices down further and the reaction hits the stock values of the producers. 

I mentioned in my last post that this stage of the commodity market is much like a breath holding contest. The strongest companies will survive with the weakest drowning (much as we suppose the Saudi oil policy has been) leaving the survivors with a scorched and fertile ground around them on which to build even stronger. The current commodity price collapse is similar to the misuse of antibiotics. They wipe out 95% of the bacteria leaving the resilient MRSA types with no competition and fresh space to colonise.

I know this is speculation but the next logical step for China is to buy up distressed commodity providers for a song. Not the commodity, the company and infrastructure that supplies it.   

But what of core demand for hard metal things and all the stuff that is made from commodities? Global demand is weak it is true, but there may be another trend arising. Aspirations appear to be changing with the arrival of Generation Y, they appear to be a generation of renters rather than owners with little desire to own one of everything. Perhaps this is born from having to live in ever cramped accommodation where it is impossible to store a lawn mower ( even if they had a garden), chain saw, workbench, ski kit, surfboard or garaging a couple of cars. Not a bad thing perhaps as I survey my garage suffering a lifetime of power tool purchases that probably see action once every two years. Renting when needed is a much more efficient use of materials. As they say, if it flies, floats or fulfils a rare need (I had to change that) - rent it. 

Perhaps the West is reaching an end to its insatiable demand for personal stuff. We have an overhang of it as my garage is testament to. Give the next generation a phone, a laptop, superfast broadband is a shoebox sized apartment, with a Starbucks and artisan burger dive next door, no car and they appear to be as happy as Larry. Suggest to one of them that they buy a large house with 6 acres for the same price as that shoebox and they ll run a mile at the thought of having to look after it. Perhaps the common theme is that the next generation cannot be bothered to look after anything as it gets in the way with enjoying themselves or earning money in jobs that program machines rather than making them. 


Antipodean said...

Excellent thoughts Pol, have been pondering similarly myself with regard to this great disinflation. In the long run it would seem to be an essential development. 3 billion will be able to have the quality of life of the current 1 billion (freedom to know, to go, to be etc).
Though as a member of Gen Y myself, I'm dubious as to wether good old fashioned materialism is dead or just hibernating.

At any rate this disinflation probably has further to run which means financial assets have further to run upside. In the medium term, US gorwth drivers shifting to consumption and housing augurs well as does tentative stabilisation in China's property sector/credit growth. Only a theory at the moment as optically things do look pretty bad still.


Polemic said...

Thanks Antipodean

ntwsc said...

Great stuff, Pol. I rather think China has still plenty of surprises up her sleeve ... the year is yet young.