Monday, 28 August 2023

By Brian Chu Editor, Fat Tail Commodities

[4 min read]

Dear Reader,

One of the most well-known follies in investing is believing that ‘it’s different this time’.

However, I have a feeling that it is different this time for commodities.

I’m referring to the current commodities boom. It’s nothing like the last super cycle that was driven by a massive building boom in China that caused a surge in demand for iron ore and other materials. In turn that fuelled mining companies to explore, develop and produce.

Now you might think that I’ve got it wrong about what’s happening this time. Isn’t there an unprecedented demand for battery metals and critical minerals to drive the clean energy revolution?

Well, yes. But why are commodity prices not surging like they did in 2005–13? Have a look at the figure showing the cumulative performance of the Bloomberg Commodities Index:

The problem is that this so-called boom is rhetoric-driven rather than reality. I wrote about this back in early July.

Commodity prices got ahead of themselves before they came back down. Meanwhile, mining companies are struggling with thinning profit margins, causing several to suspend production to preserve their capital.

That doesn’t sound like a boom to me when they’re battening down the hatches!

Depending on whether you trade the momentum or look for bargains, knowing this fact will help you formulate your winning strategy. This is what I want this article to accomplish.

Let’s delve deeper into this unusual situation.

The most counterintuitive commodities boom

If this really is a commodities boom, it’s the weirdest boom. You’d have to believe it against the evidence from the companies.

I’ve tracked the performance of gold producers in the 2023 June quarter, which was largely underwhelming with lower production and higher costs.

It seems like this trend has been playing out for other metals too. Iron ore, copper, aluminium, zinc, nickel, everything!

Don’t get me wrong, I’m not pouring cold water on commodities. But I’m saying that there are plenty of signs to say that the narrative about a boom playing out right now just doesn’t jive with reality.

Earlier last month, the ABC reported that Australian export revenue from resources for 2023–24 could decline by over 15% from $460 billion ($455 billion according to the Minerals Council of Australia) in 2022–23 to $390 billion. This comes as coal and gas exports might decline by 25–50% while critical metals for wind turbines and electric vehicles such as cobalt could increase for the following year.

In short, declines in revenues from fossil fuels will likely overshadow the increase in revenues from resources associated with renewable energy.

Correct me if I’m wrong, but the past booms we’ve had come largely from a surge in demand causing supply to increase. So, the supply shortage is a response to people wanting more. As this happens, the price of the required material rises and slowly falls as producers gradually bridge this gap.

In the past, governments and regulatory authorities would ease restrictions to facilitate the booms. Think about how the Howard Government in the early 2000s increased trade with China and offered incentives for mining companies to fast-track production.

This time round, it’s the opposite.

The world’s supply chain almost shut down for the last three years and things are just starting to revert to normal. But you can sense that there’s a lot of sputters and clunking in the engine.

Throw into the mix artificial restrictions from governments and international organisations as it seeks to meet the globalist’s dream of shifting the world to renewables in lieu of fossil fuels. And don’t forget the aggressive monetary policy by central banks around the world stifling investment and growth.

It’s like taking a truck out for a drive for the first time after a decade but overloading it and puncturing the tyres first!

Does any of this make sense? I’ll let you decide.

A self-inflicted commodities shortage

I came across another article from Forbes.com that talked about how the world needs to overcome a critical minerals shortage in the coming decades because of ‘The Green Agenda’. It’s penned by Oliver Gunasekera, the CEO of Impossible Metals Incorporated.

The premise of the article is that the world is moving to net zero to meet the goals of reducing carbon emissions in the coming decades. However, there are insufficient resources to accomplish this if we move at the current pace.

The author offered some options to combat the challenges.

The first is to seek to restrict demand. The second is to use alternative materials and technologies. The third is to consider expanding the mining sources, including from the ocean and space.

These suggestions may address the challenges raised in the article. However, it’s my opinion that they’re illogical and even unnecessary.

Firstly, there’s no need to restrict demand. A demand-driven boom is usually healthy, while a supply-constrained boom that we’re trying to orchestrate isn’t. This is because the market can use demand to signal what is needed and deliver it accordingly. Constraining either supply or demand to steer market behaviour creates unintended consequences and invariably leads to waste.

To cite a recent example, think about how many communal bicycles were wasted a few years ago when local councils bought thousands of them to try to encourage a ‘sharing economy’.

Secondly, fossil fuels currently produce 80% of the world’s energy. It’s one thing to seek to encourage industries and households to shift to renewable sources. But forcibly banning or sharply curbing its use when the renewables industry is still a small market is silly.

I’m not against considering alternative materials for batteries and electronics. What I find ridiculous is the manner this transition is occurring.

Put simply, it violates the basics of sound microeconomics. Market intervention causes inefficiencies! In this case, we’ve taken it to an industrial scale!

And the third option of seeking innovative sources to mine the materials, I’d say that’s like adding a fifth wheel to a car. It’s unnecessary and unlikely to address the current challenges.

Yes, some materials are depleting. Conventional mining is more costly as ore grades are declining. However, adopting deep sea or even space mining will likely add to costs rather than result in cheaper supply.

Put bluntly, we’re seeking idiotic solutions to straightforward problems.

Profiting from our folly

Just as there’s folly in believing that ‘this time is different’, the situation we’re faced with in the commodities space is one of wilful stupidity.

Commodities are currently going through a supply constraint amidst weak demand. It’s the worst of both worlds.

However, the future is brighter because eventually, the free markets will overcome the interventions and restrictions that are holding it down. It’s a matter of time.

Many who have invested in mining stocks in the past year or two are sitting on some hefty losses. To add, enthusiasm for lithium and rare earth companies is now cooling.

The short-term outlook isn’t ideal, but the cure for low prices is low prices. Many companies are cutting back production which will eventually create a boom as demand causes prices to rise again.

Therefore, you should make your move now and learn more about where the opportunities are. Throw out your net before everyone else gathers for the pickings.

Check out James Cooper’s Diggers and Drillers if you want to learn about the hot commodities to get into now. Or you can join me at The Australian Gold Report for everything related to precious metals and mining companies.

God bless,

Brian Chu,
Editor, Fat Tail Commodities