Grantham: 'It's Time to Wake Up' to a Paradigm Shift in Commodities

(March 26, 2011) — Jeremy Grantham, the co-founder of the US investment firm GMO Capital Management, which in 2006 predicted the housing crash, says 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 GMO’s latest 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.

Grantham indicated that the prices of all important commodities, excluding oil, declined by an average of 70% in the past 100 years until 2002. However, since then, colossal price increases wiped out the declines, driven by heightened demand from developing countries, such as China. Inflation-adjusted commodity prices are nearly exactly where they were in 1900, he said.

According to Grantham, who is credited with warning of the economic downturn in February 2006 when he told Barron’s magazine that “housing is a classic bubble,” long-term investors must alter their frame of reference to adapt to this rapidly changing world in which shortages will be common. He writes: “If I am right, we are now entering a period in which, like it or not, we must finally follow President Carter’s advice to develop a thoughtful energy policy and give up our carefree and careless ways with resources. The quicker we do this, the lower the cost will be. Any improvement at all in lifestyle for our grandchildren will take much more thoughtful behavior from political leaders and more restraint from everyone. Rapid growth is not ours by divine right; it is not even mathematically possible over a sustained period…Because we have way overstepped sustainable levels, the greatest challenge will be in redesigning lifestyles to emphasize quality of life while quantitatively reducing our demand levels.”

Institutional investors have been active players in commodities. According to a February report by Barclays Capital, net inflows to commodity-related investment are expected to remain strong in 2011, driven largely by institutional investor demand. “The return of the institutional investor, massive inflows into precious metals led by the desire to hedge against financial market risk, and the gradual shift towards active management of commodity strategies were among the key stories of the year,” the Barclays report said.

Click here to read Jeremy Grantham’s April 2011 quarterly letter.