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Jeremy Grantham Gets Bullish on Commodities in His Latest Outlook

by Brett on May 14, 2011

Welcome aboard the commodity bull, Jeremy Grantham!  In his latest quarterly outlook letter, the acclaimed money manager (and excellent newsletter writer to boot) laid out a very convincing case for commodities.  You can read Grantham’s Q1 2011 letter here (for Part I) and here (for Part II).

I found these points of his to be especially interesting:

  • The prices of all important commodities except oil declined for 100 years until 2002, by an average of 70%. From 2002 until now, this entire decline was erased by a bigger price surge than occurred during World War II.
  • 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.

(Source: www.GMO.com)

The crux of Grantham’s “This time is different” argument for commodities is that Planet Earth post-1800 was a unique place, as the sudden, cheap availability of seemingly endless hydrocarbons allowed human population and wealth to explode.

He points out, correctly, that compound growth is a mathematical impossibility over the longer term.  Most human beings do not realize that even modest rates of compound growth are impossible over a long time period because, if you achieved them, you would eventually own all of Planet Earth, and then the entire Milky Way Galaxy and beyond.

This idea turned Grantham on to commodities several years back.  Recently, he and his team undertook an extensive research project, taking a hard look at commodity fundamentals and prices for the 102 year commodity bear market, which he believes lasted from 1900-2002.

I share Grantham’s longer term sentiments for commodities…ever since reading Jim Rogers’ classic and prescient Hot Commodities in 2004, I was sold on the fundamental reasons why commodity prices would rise for the next decade (at least).

But, couldn’t we see a wicked 2008-style setback, say, if China stumbles?

Grantham thinks it’s quite possible – and recommends proceeding with caution:

How does an investor today handle the creative tension between brilliant long-term prospects and very high shortterm risks? The frustrating but very accurate answer is: with great dif?culty. For me personally it will be a great time to practice my new specialty of regret minimization. My foundation, for example, is taking a small position (say, one-quarter of my eventual target) in “stuff in the ground” and resource ef? ciency. Given my growing con? dence in the idea of resource limitation over the last four years, if commodities were to keep going up, never to fall back, and I owned none of them, then I would have to throw myself under a bus. If prices continue to run away, then my small position will be a solace and I would then try to focus on the more reasonably priced – “left behind” – commodities. If on the other hand, more likely, they come down a lot, perhaps a lot lot, then I will grit my teeth and triple or quadruple my stake and look to own them forever. So, that’s the story

I have personally come to a similar conclusion myself (and reading Grantham’s piece helped me cement my thinking on the subject).  From 2004-07 I did quite well investing in and trading commodities, but I used too much leverage, and gave back much (but fortunately not all) of my profits in the 2008 crash.  And I’ve been more or less licking my wounds ever since.

If you believe in the longer term commodity play, then the cautious way to do it is to carefully establish your positions.  And if commodities do have a setback, it’ll be a great time to accumulate some more, at cheaper prices.

As Jim Rogers pointed out when I spoke with him last month, new supply is just not coming online any time soon.  Historically, commodity bull markets have ended when supply was able to recover and outpace demand.  This doesn’t happen overnight in the best of times – and there’s evidence that new supply could take even longer to come around this time.  Because, as Grantham points out, demand has been inflated to quite high levels, thanks to humanity’s breathtaking 200-year bull run.


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