Commodity Secular Bull Market Continues

By Chris Puplava, January 13, 2010

Co-Manager of PFS Group's Precious Metals Managed Account, Energy Managed Account, and Aggressive Growth Managed Account

From 2008 to 2009 it was a real gut check for commodity bulls in terms of reevaluating the secular bull market thesis, but from my vantage point the fundamentals behind commodities have not changed. What 2008 to early 2009 is likely to represent in hindsight is a bump along the road not unlike the mid 1970s correction in commodities before the 1980 bubble top or the 1987 market crash before the 2000 stock market peak. What 2008-2009 also showed is the importance of capital preservation as taking periodic profits ensures that profits gained are not lost.

One of the key drivers for higher commodity prices this decade was a devastating secular bear market in commodities in the 1980s to 1990s that led to production cutbacks due to lower prices and many commodity-related companies were gobbled up by the majors. As we entered this decade the sleeping giant that is China emerged at the same time commodity production capacity was low. Throughout the decade supply has struggled to keep up with demand with periodic price spikes occurring in various commodities when supply levels became strained. While it appeared to some that commodities represented a bubble in 2008, nothing could be further from the truth. Since the peak in commodities that occurred in 2008 we have seen two major developments that supports the notion that the thesis behind the secular bull market in commodities is as strong as ever. For example, in 2008 for the first time ever non-OECD countries surpassed OECD countries in terms of global energy consumption as the developing nations became more important than the developed countries in gauging world energy consumption.

Source: Bloomberg

Another first is that Chinese auto sales now eclipse US car sales as China is now the world’s top auto market. It is not just China that is showing robust auto sales as India and Brazil are also experiencing high growth in auto sales as the articles below illustrate.

Source: Bloomberg

The growth story in developing countries did not skip a beat during the global recession as their real GDP growth rates led the developed nations heading into the global 2007-2009 recession and their real GDP growth rates are leading the developing countries out of the recession as IMF figures below show. While global economic growth has come down from the highs seen a few years ago, world economic growth is still strong and commodities will continue to be necessary to support this growth.

Source: IMF Data Mapper

As mentioned above, 2008-2009 was a real gut check for commodity bulls as commodity prices collapsed, but when one studies history the collapse in 2008-2009 was not out of the norm as nearly an identical collapse was seen in the middle of the 1970s during the last secular bull market in commodities. This comparison can be seen below when comparing the current CRB Raw Industrials Index to its 1966-1981 secular bull market in which a sharp correction took place in the middle of the secular bull market in 1974-1975. After that sharp sell off commodities recovered strongly and went on to nearly double in price to close out the 1970s. We appear to be continuing that secular bull market script as commodities recovered strongly in 2009 and are building on those gains this year. A similar pattern is also seen when comparing the S&P 500 Energy Index this decade versus the commodity price pattern seen in the last secular bull market in the 1970s.

Source: Bloomberg

As you can see in the two charts above, using the price and time pattern for the last secular bull market in commodities signals an end for the current bull market in commodities in 2014-2015. Interestingly, this time line coincides with the secular bull market work I did on commodities last year as well as the work on secular bear markets in stocks I did in 2008. Typically, when the stock market is in a secular bull market commodities are in a secular bear market and vice versa, and so it’s not surprising that my projection for an end to the secular bear market in stocks that began in 2000 by 2013-2015 should roughly coincide with the end of the secular bull market in commodities. For further information, readers that are interested can browse my prior reports on secular bear markets in stocks and secular bull markets in commodities with the following links below:

Secular Bear Market in Stocks:

Secular Bull Market in Commodities:

One of my favorite economists is former Merrill Lynch chief North American economist David Rosenberg who is now with Gluskin Sheff in Canada. Mr. Rosenberg and I are in agreement with the view of a continued secular bear market in stocks and a continued secular bull market in commodities. Mr. Rosenberg presents a compelling argument for both cases and an excerpt from a report he made last year is presented below:

Special Report: The Case for Commodities, Credit and Canucks (09/25/2009)

We believe that the commodity market entered a secular bull market right around the same time that the equity market entered its secular bear market — a tad later actually, in November 2001. Not surprisingly, the last secular bear market in equities, from the mid-1960s to the early 1980s, also took hold alongside a secular bull market in commodities; we are seeing something very similar take hold this time around but for very different reasons.

What really caught our eye this time around was that during the vicious selloff in commodities last year, the price of virtually every commodity bottomed at a higher price than during any other recession in the past. Oil, for example, bottomed this cycle at $39.20/bbl (using monthly averages). In the 2001 recession, the oil price bottomed at $19.33/bbl; in 1990, it bottomed at $16.81/bbl; in 1982 at $28.48/bbl; and in 1975 at $10.11/bbl. We bottomed this cycle at levels that were peaks in prior cycles.

The same holds true for copper — it hit its trough at $1.39/pound this time around versus $0.630 in 2001 and $1.00 in 1992. Ditto for the ‘softs’ — soybeans bottomed at $8.48/bushel this time, compared with $4.15 in 2001, $5.42 in the recession of the early 1990s and $5.32 in the early 1980s downturn.

Take the entire CRB spot index and again it is plain to see: the bottom this cycle was 307.4 versus 211.2 in 2001, 237.5 in 1992, 226.8 in 1982, 187.2 in 1975 and 107.1 in 1971. We are impressed.

In a recent report from Mr. Rosenberg, he also presents a compelling case that 2009 did not mark a secular bear market low for stocks as the table below makes abundantly clear:

Market Musings & Data Deciphering: Breakfast with Dave (01/06/2010)

One reoccurring sign of a bubble and the end of a secular bull market is when the public finally jumps on board as the public is always last to the party. We saw this with commodities at the end the 1970s and early 1980s, with technology at the end of the 1990s, and in the financials this decade. One can view these investment bubbles by looking at the weightings of various sectors within the S&P 500. As shown below, bubbles are reached when a given sector or related sectors (Commodities = energy + basic materials; Consumer/finance-related = financials + consumer discretionary) represent 35% or more of the entire S&P 500 market capitalization. We have seen three such bubbles over the last three decades and using this criteria there is no way anyone can say commodities were in a bubble in 2008 as the combined S&P 500 market share of energy and basic materials only reached 20%. This is less than half the level seen during the last secular bull market in commodities and well below the level seen in Technology in 2000 or the combined financials plus consumer discretionary sector weights in 2007. With the current combined weight of 15% for commodities in the S&P 500, there is considerable room for commodities to grow in terms of market share before one can even entertain the notion of a bubble.

Data Source: Bloomberg

When looking at the timeline and overall trend of market share in the S&P 500, the energy and basic materials sectors are tracking a similar path as technology did in its bubble days in the 1990s. This can be seen below with the technology sector weighting of the S&P 500 shifted so that the 1998 sell off in technology shares coincides with the 2008-2009 sell off in commodities.

Data Source: Bloomberg

While the comparison to the Tech bubble above projects the S&P 500 commodity-related sectors to rise sharply over the next year, we may enter a consolidation period first before another major leg higher. This was the pattern seen in the middle of the last secular commodity bull market in which commodity prices recovered strongly after the 74-75 bear market and then consolidated for a little over a year before heading higher. The first chart of this article is repeated below to show this comparison in which the 1966-1981 CRB secular bull market analogy projects a consolidation from the middle of 2010 to late 2011.

Data Source: Bloomberg

Further support for this consolidation thesis for commodities before they undergo another leg higher is the trend in Chinese financial loans. As China is the global growth engine the growth in China has a direct impact on commodity demand and there has been roughly a seven month lead time between the growth rate in Chinese total financial loans and the CRB Index. The peak in 2007 for Chinese loans came roughly seven months ahead of the CRB peak in 2008 and the financial loan growth rate bottomed in 2008, again seven months ahead of the CRB bottom in 2009. The stalling in the growth rate of financial loans in the middle of 2009 may be foreshadowing a consolidation period ahead for commodity prices with a the seven month lead time in financial loans projecting the CRB to rise into the spring before consolidating.

Source: Bloomberg

In the short term, for those wanting to play a potential rise in commodities in the first half of 2010 before a consolidation period, the sector analysis I performed in December (Sector Rotation) remains unchanged as the energy sector is more attractive than the materials sector whose valuations are beginning to get a little frothy. While the long term secular bull market in commodities remains intact, there will be periods when it will be prudent to take some money off the table as boom and bust commodity prices lead to economic boom and busts. Additionally, this secular bull market in commodities is different than the 1966-1981 secular bull market in commodities, as this cycle is within the confines of a secular credit deleveraging cycle and there remains severe economic headwinds for the U.S. and other developing nations. This backdrop will likely make the current secular bull market in commodities more volatile and capital preservation should thus play a larger investment role than it did in the last commodity secular bull market. Hence the suggestion for taking profits when valuations become stretched.

Chris Puplava

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Christopher M. Puplava
PFS Group
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