(February 15, 2012) — This time is not really different for commodities, according to a newly published research paper by Morgan Stanley Investment Management.
“Lots of people firmly believe that commodities are in a ‘super cycle’, meaning a prolonged trend rise in real commodity prices. It is a view rooted in powerful and real trends, like the growth of China and India, the decline in global energy reserves,” the paper by Ruchir Sharma, Munib Madni, and Jitania Kandhari of Morgan Stanley Investment Management claim.
The main thrust of the paper: The extraordinarily high correlation between commodities and equities is not sustainable.
According to the paper, the role that high oil prices have played in triggering the latest relapse in the US economy is severely underestimated. “Out of 11 recessions in post-World War II US history, oil price spikes have preceded 10…Oil prices over the past 12 and 24 months have surged by an even greater magnitude and energy expenditures as a share of consumer spending at 6 percent are at levels that have badly hit consumer spending in the past. It took a double-dip recession in the 1980s to kill the commodity bull market and set the stage for a sustainable recovery to begin in 1982.”
The authors conclude that as higher prices further destroy demand, “commodities prices are sowing the seeds of their own self destruction.” Consequently, according to the authors, the relationship between equities and commodities will need to uncouple for one of them to continue advancing.
Furthermore, the authors note that China’s unique role as a driver of commodities prices is also vulnerable. The authors write: “The country has reached a critical plateau in growth. We believe the rest of the world — emerging and developed alike — is not capable of compensating for China’s astounding share of commodities demand.”
The paper by Morgan Stanley Investment Management follows an October study — titled “Long-Short Commodity Investing: Implications for Portfolio Risk and Market Regulation” — by the EDHEC-Risk Institute, which shed light on the future of commodity investments.
A number of policy-makers have blamed the decade-long rise in commodity prices and recent market volatility on the growing influence of financial investors and have called for new regulation restricting their participation in commodity markets, wrote the author, Jolle Miffre, EDHEC-Risk Institute Professor, with market data and support from CME Group. In addition, market financialisation has also led investors to worry about higher integration between commodity and traditional financial markets weakening the portfolio benefits of commodity investment, EDHEC noted.
The study aimed to provide clarity on whether greater use of commodities as investment tools has resulted in such investments consequently losing their traditional strength of non-correlation with financial investments.
Meanwhile, Jeremy Grantham, the co-founder of the US investment firm GMO Capital Management, which in 2006 predicted the housing crash, said in March of last year that it’s ‘time to wake up’ as the days of plentiful resources and falling commodity prices are a thing of the past. “The world is using up its natural resources at an alarming rate, and this has caused a permanent shift in their value,” Grantham wrote in a GMO quarterly newsletter. “We all need to adjust our behavior to this new environment. It would help if we did it quickly.”
“Statistically, most commodities are now so far away from their former downward trend that it makes it very probable that the old trend has changed – that there is in fact a Paradigm Shift – perhaps the most important economic event since the Industrial Revolution,” he wrote.