Sunday, October 1, 2023

Clarity

Bridging the Gaps: Between Investment and Global Resource Trends

Resources (Commodities), 2014

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The Stone Age did not end through lack of stones

Developed societies demand many resources. These includes what traders and investors call ‘commodities’ — broadly food, minerals (metals and non-metals) and fuel, but also those such as biodiversity whose monetary value does not yet accurately capture ‘true value’, if at all. There has been much discussion for about whether one or other resources are running out. However, assessment of the adequacy of global reserves requires care. After all, the “Stone Age did not end through lack of stone”, but because we found something better. If resources are in short supply, this stimulates a search for more, or for alternatives. It is only if there are no substitutes (water for agriculture) or these are expensive, or otherwise impractical, or have other side-effects, that problems arise.

… the world is not about to run out of the resources listed by USGS in 1992 … But that does not mean they were incompetent

To get a sense of how important this is, rather than look at current assessments it is interesting to look at how a past assessment of known global reserves against annual production (consumption) panned out. Past projections of the global reserves of mineral resources can be a useful corrective against excessive pessimism. The graph below shows one such assessment, by the US Geological Survey in 1992, almost 25 years ago, that evaluated rates of global use against know global reserves. The immediately point to make is that the world is not about to run out of the resources listed by USGS in 1992 with an adequacy of 25 years or less (to the left in the graph below). But that does not mean that they were incompetent. Rather the ratio of minerals available to production and consumption have increased (new finds, ability to exploit lower grade reserves, better recycling, lower demand, substitution). The second point is how rapidly the assessed adequacy of reserves can change. Rare earth metals and other elements (‘re’ in the graph below) were to the extreme right of the 1992 assessment, with reserves estimated to be adequate for over 1000 years. Since then, with the demand of rare earth elements for electronics, we have gone through predictions of extreme shortage and geopolitical risk (because the main sources were all in China) to some relaxation of concern now, in this case because the risk did lead to an assessment of alternatives, and new reserves in other parts of the world have since been identified.

USGS 1992 assessment of adequacy of global reserves. Minerals ranked in order of then known adequacy of reserves in years, shown on a logarithmic vertical scale. These ranged from Indium (In) and gold (Ag), both under 20 years, through to rare earths (re) and soda ash (sd), projected to have global reserves over 1,000 years. Mineral labels colour tinted and centred to appropriate column and indicated by chemical element symbols or by the following: di=diamond, pt=peat, gr=graphite, fl=fluorspar, oil, gas=natural gas, Il=Ilmenite (iron/titanium mineral), ver=vermiculite, ptg=platinum group, r=rutile (titanium mineral), p=potash, coal, dtm=diatomite (silica from diatom algae fossils), ss=sodium sulphate, re=rare earths, sd=soda ash. Source: USGS (2007)

Does that mean we can relax? Probably not. After all, the adequacy of most reserves were and still are measured in decades rather than centuries, which is not so comforting. And the rates of exploitation were lower in 1992, the global economy was smaller than now, certainly much smaller than the explosive growth in services that these resources currently support for 9-10 billion to live well — if that is to be supported by a materials consumption and production infrastructure similar to now.

… are … commodity prices increasing, indicating that resources could become a constraint on growth? The answer appears to be yes

So the next question is whether there are there signs of commodity prices increasing in real terms, corrected for inflation, indicating that resource availability could become a constraint on growth? The answer appears to be yes, at least as judged from the longest-running International Monetary Fund (IMF) Commodity price indices for metals, and also fuel and food (below). These shows a sharp uplift in prices across the board since the start of the new century. Although the news of 2013-14 has been of falling commodity prices, they still remain well above the historic prices. Nevertheless, these only run from 1980, so it is not possible to tell whether this is unprecedented on a longer time scale.

Above: IMF Food, Metal and Fuel Commodity Price Indexes 1980–2014 Three of the longest running IMF Commodity Indexes, from 1980 to current, for Agricultural Raw Materials (PRAWM), for Metals (PMETA) and for Crude Oil (POILAPSP), with the index set to 100 for the average 2005 price for each index. These are based on the $ price at the time. Source: IMF Primary Commodity Prices where the available data files breaks this down into a large number of sub-components for further analysis.

Extending the data back further is a challenge by the respected Jeremy Grantham and asset managers GMO. As below, they have constructed an index from 33 commodities extending back to 1900.

Commodity Prices 1900–2010 and Grantham’s ‘Great Paradigm Shift’

Above: Commodity Prices 1900–2010 and Grantham’s ‘Great Paradigm Shift’ Grantham/GMO commodity index, calculated from 33 commodities, vis: aluminium, coal, coconut oil, coffee, copper, corn, cotton, diammonium phosphate, flaxseed, gold, iron ore, jute, lard, lead, natural gas, nickel, oil, palladium, palm oil, pepper, platinum, plywood, rubber, silver, sorghum, soy-beans, sugar, tin, tobacco, uranium, wheat, wool, zinc.  Source: Grantham (2011a), (2011b) (requires free registration)

… remarkably, the rise in global commodity prices 2002-11 has entirely erased a century-long inflation corrected -1.2% annual fall

GMO’s analysis is that, remarkably, the rise in commodity prices 2002-11, also featured in the IMF data, has entirely erased a century-long fall in commodity prices, which between 1900–2002 had averaged an inflation corrected -1.2% annual fall, and a cumulative 70% overall, across the basket of commodities. But also, that decline had not been constant: in reality it came from an unprecedented run of declining commodity prices starting around 1980. Grantham, for one, is convinced that the surge in global commodity prices between 2002–2011 is the ‘Great Paradigm Shift’; a fundamental increase in demand since 2002 that will not revert to mean, the first sight of what is to come as a result of ‘middle class’ global consumption increases as envisioned by the NIC (see drop-down The role of China).

As already mentioned since 2011 when GMO’s analysis ends, and especially since 2014, the focus has been on the global economy stalling, and commodity prices falling. So it’s reasonable to ask whether this has shot Grantham’s Great Paradigm Shift fox, and we are now seeing a reversion to mean? But if one examines the graph in the drop-down IMF Commodity Price Indices 1980-2014, while there are big variations in the individual components, and although the indexes are not identical, it appears that the broad plateau of commodity prices at a historic high 1980-2014 is likely to have maintained the Great Paradigm Shift. So the fox is alive and kicking. When the global economy starts to grown as vigorously as assumed, and if commodity prices then start to rise, it will have survived a significant test.

GMO does not discuss their detailed methodology, so one is limited in what one can say regarding the uniqueness compared to earlier peaks and troughs. What one can say is that other periods of peak prices; World War I, World War II and its aftermath, and the 1970s OPEC oil-price hike all had temporary causes. This time things may be different.

The greatest increases from 2002 in iron ore, coal and copper, but 23 of the 33 commodities individually exceeded GMO’s statistical test of an extreme event (GMO’s successful business model, with $110b of managed funds in 2011, is in identifying such statistical extreme events in general business and betting on a reversion to mean. Except in this case Grantham does not anticipate such a reversion). It was driven by increased consumption by emerging markets, notably China, which by 2009 was consuming 53% of global cement production, 48% of iron ore, 47% of coal, 46% of pigs, 45% of steel, 45% of lead, 41% of zinc and aluminium, 39% of copper, 25% soy-beans and much else. During this period China’s capital spending was over 50% of GDP, an extraordinary amount. Since the time of Grantham’s analysis, commodity prices have stabilised in the wake of the Great Recession, but have not fallen back. Should the global economy start growing as before 2007, the real price increase in commodities can be anticipated to start again.

Summing up, scarcity and increasing commodity prices may choke off growth and any potential for perhaps ten billion to live well by 2050. If it does not, it will be because substitutes for minerals in short supply will be found that bring costs back down. But the search for substitutes may take a decade, with another decade for widespread adoption. Over-hasty adoption without adequate research brings its own risks. So it doesn’t pay to delay, and it is a function of the governance of innovation to ensure that research is done where markets are unlikely to be efficient or timely.

Source: Trends to Bend, modus vivendi, 2014, MMG