Crowded House

Something, quite clearly, does not add up. The consensus has it that the US is in recession, and that the US recession will cause the rest of the world to catch cold.

But if that analysis is right, why are copper and oil hitting all time highs? And why is the CRB Rind – an index comprising many basic non-exchange traded commodities – like hemp, steel scrap and butter – why is that up near an all time high as well?

In short, it’s because there is no global recession. Not only is there no global recession, but global commodities demand growth will likely be above trend again this year. And global commodities supply growth will likely be below trend again this year, despite record prices.

And my view is simple – commodity fundamentals will continue to ratchet tighter, and commodity prices will continue to ratchet higher over the next couple of years.

When I was a commodity strategist at ABN I reckoned that if I could call commodity demand cycles I could make a living. But if I could call changes in intensity of use, I could make a fortune.

We’re right in the middle of a major change in intensity of use. Broadly speaking, the commodity use in a dollar of growth in the BRICs (Brazil, Russia, India and China) is around four or five times greater than the use in a dollar of growth in the US.

One factoid tells the story quite nicely – the US economy is now around twice the size it was in 1982. But a year of growth now weighs no more than it did back then. China’s economy is around twice the size it was in 1999. But a year of growth now weighs around three times as much.

The key issue is where the world’s growth is coming from. If two thirds is coming from the US and the developed world, as it was in the late 1990s, then commodities demand will struggle. But my calculations show that, if two thirds comes from developing countries, as it is now, it will double the trend commodities demand. The kind of slowdown I’m expecting in the US won’t be enough to pull commodities demand back below trend.

Now the next issue is whether the US slowdown will undermine growth elsewhere. Normally it does – whenever the US falls into recession, it’s current account deficit shrinks. And that means fewer dollars for the rest of the world. It is the loss of liquidity that undermines profitability, and then growth, outside the US. But something very strange is happening – because while the US current account deficit is duly contracting, global liquidity – as measured by global reserves – is actually expanding. And not only is it expanding, it is accelerating. That’s pointing to a reacceleration of growth, not a global recession.

And profitability in the BRICs is pointing to a longer cycle. When the cost of capital rises above nominal growth – like it did globally in 1999 – it is a sure fire harbinger of macro doom. But that is very far from being true in the BRICs now – the cost of capital is close to 5%, but nominal growth in the BRICs is over 10%.

That’s quite a combination; accelerating global liquidity, strong emerging market profitability, above trend commodity demand, and below trend supply.

Things are going to get a lot hotter before the commodities complex tops out.