Commodities
Commodities are volatile investments and should form only a small part of a diversified portfolio. Investments in commodities may be affected by overall market movements, changes in interest rates, and other factors such as weather, disease, embargoes and international economic and political developments.
The role of infrastructure as a driver of economic activity, and consequently, of demand, is also often underestimated. Growing markets have transportation requirements, such as roads, waterways, railways and buildings, as well as facilities to ensure the supply of water and electricity. They also need commodities – and this is boosting demand.
The OECD estimates that in the period China alone will have to invest about $2 trillion in power plants for electricity generation and distribution. At present the country already invests approximately 20% of its gross domestic product in infrastructure. However, even developed countries have work to do. In the years to come, the OECD expects the US and Canada to invest around $1.8 trillion in their electricity infrastructure – not much less than China. This means that even if commodities are subject to cyclical fluctuations, the sustainable drivers we have discussed could ensure long-term demand for commodities maintains its pace even beyond financial crisis.
And the supply side? Long-term rising demand is coupled with the fact that few new capacities have emerged on the production side during the last few years. Partially, this was because in the and early “too much” was being invested in new capacity that was more efficient and less expensive. It took several years for this excess supply to be soaked up.
This was reinforced by severe economic crises in Asia and Russia. During this time, the inflation-adjusted prices of many commodities reached their lowest levels in over 100 years in the mid-. Additionally, when the high-tech bubble began to inflate, it made more economic sense to invest in information technology rather than search for new sources of raw materials.
At the same time, natural resources are becoming scarcer, or access to them is becoming more difficult and more expensive. Although exploration expenditures of companies increased significantly from to, most investments (: 41%) were made at the locations of known deposits or in exploring in the immediate vicinity of already developed reserves (27%). Only 32% of expenditures for exploration went to discover completely new reserves – so far with relatively little success.
Technology won’t save us
A similar phenomenon has been observed in oil production, where the development of new reserves is becoming increasingly difficult and expensive. While new technologies allow for deep-sea drilling at depths of more than 4,000 meters, almost no major oil fields have been discovered in recent years, with the exception off the coast of Brazil (“Tupi”). This is located in extremely deep water under layers of hard rock and salt, making it very difficult and expensive to develop. The sinking of Deepwater Horizon and the subsequent oil spill in the Gulf of Mexico have shown significant risks are associated with deep-water drilling. Meanwhile, the major reserves discovered in the middle of the last century, primarily in the North Sea and off the coast of North America, have peaked and are drying out. This means that scarcer supplies are working in tandem with declining output by the oil companies.
And even if new sources of commodities were found in the near future, it generally takes four to eight years to bring these to market. Lengthy approval processes, infrastructure development in remote regions and specific new technical challenges are among the most cited reasons for the long lead time for mining projects.
Skilled labor is also frequently difficult to come by. Who would have chosen to study mining instead of marketing in the late?
Finally, there are often political obstacles to the expansion of commodity production. Even in the agricultural sector, the supply of livestock and food cannot be expanded at will. With the rapid urbanization of the world’s population – in, for the first time in history, more people lived in cities than in rural areas – the amount of arable land has decreased. Simultaneously, the shift in agricultural production to biofuels from food has increased competition for land.
Commodity production can scarcely keep up with the dynamic development in global demand. The supply bottleneck could remain a sustainable driver of higher commodity prices for the foreseeable future. This applies to energy, to commodities in general and agricultural products in particular: these resources are becoming scarcer – and this is a megatrend.