The Commodity Boom Is Over

If you've read the World Bank's new Global Economic Prospects report (and we know you did), then you might today believe that the world has seen the last of high-priced commodities. The World Bank's economists argue convincingly in the report that the dramatic rise in commodities prices over the past five years was driven mainly by a shortage in supply caused by decades of underinvestment in mines, wells, and refineries.

Now that the global economy is cooling, and poor yet rapidly growing countries can no longer afford to pay up for the resources they need to drive development, the end of this boom has arrived. The report argues that this cool-down period will provide time for capacity to grow so that demand and supply are in synch going forward.

History agrees
When previous booms ended, it took quite some time for prices to bottom -- 11 years and 19 years, respectively. In fact, since 1900, non-energy commodities prices show a fairly steady trend downward.

If the recent plunge in commodity prices portends a repeat of history, it isn't exactly great news for companies such as Monsanto (NYSE: MON  ) and Southern Copper (NYSE: PCU  ) . But it spells more serious trouble for those developing countries that are generally considered both the cause and the greatest beneficiaries of the recent increases in demand. Russia, Brazil, Indonesia, and several other emerging markets have economies that are driven by natural resources.

Not so fast
The report also names China as the main source of demand growth for metals and oil during the boom years. Yet, as China's manufacturing expansion slows -- as we discuss below -- the argument goes that they won't need to continue building and fueling enormous cities.

However, with more than half the country's population still living and working in rural areas, there's still plenty of pent-up demand for urban infrastructure, residences, and jobs -- especially when you consider that the rural population in the U.S. is somewhere around 20%. So, it would appear that the engine for the recent commodity run still has a few laps left.

That sound you hear ...
... is Vladimir Putin grinding his teeth as he reads the World Bank's analysis. When oil was fetching $145 a barrel, Russia and other major oil-exporting countries were living like rock stars. As oil prices have plummeted, they've had to give up drugs and think about starring in a reality sitcom on a mediocre cable channel.

See, the Russian stock market is down some 70% over the past year. While companies in the States like Citigroup (NYSE: C  ) , General Motors (NYSE: GM  ) , and AIG (NYSE: AIG  ) have had plenty of problems, the global credit crunch has caught many of Russia's largest companies with their over-levered pants down. Manufacturing production has fallen below 1998 levels, the year Russia defaulted on its sovereign debt, and the ruble is tumbling.

Now, Russia was smart enough to stash away its windfall profits of the past few years. But it's burning through its $450 billion of reserves as the government buys up rubles and infuses banks and other companies deemed vital to state interests with cash.

All of this firefighting means that there is much less cash available to Russia to develop more infrastructure and help the country diversify its economy away from oil. In fact, estimates show that Russia needs sustained oil prices of $70 next year just to balance its budget. While we should get there eventually, next year could be a volatile one for the motherland.

Speaking of $70 oil
Collapsing oil prices have also prompted negative reports on Mexico, another country that relies heavily on petrodollars. Perhaps most notable in this regard was a recent Forbes cover story that proclaimed a "Mexican Meltdown."

While Mexico has its share of economic problems, ranging from rampant drug violence and a slowing U.S. economy to a state-run oil company that's unable to invest effectively in exploration and production, our Global Gains team recently visited the country and found that if you're willing to drill down on quality, there are some intriguing opportunities there. That's because the country today is on much firmer financial footing than it was during a previous crisis in 1994.

Specifically, the country has hedged its oil production and locked in revenues of $70 per barrel for all of 2009 -- Russia, in its imprudent greed, did not. And the economy is starting to diversify, though it does remain heavily levered to oil, manufacturing exports, and tourism.

The fact of the matter, however, is that these recent events are scary, and investors are fleeing emerging markets at a rapid pace. That creates opportunity if you're willing to be patient and buy best-of-breed companies such as America Movil (NYSE: AMX  ) and Wal-Mart de Mexico (OTC: WMMVY.PK). These companies may see disappointing results in Mexico next year, but they have cash-rich balance sheets that will help them weather the storm and emerge even stronger on the other side.

Finally, the "below" we previously told you to see for more details
We learned yesterday that the value of China's exports dropped 2.2% in November -- the first monthly decline in more than seven years. That's a consequence of slowing demand for, well, pretty much everything around the world.

While that may not sound like big news to U.S. investors who have gotten used to a declining export sector and massive trade deficits, the fact is that exports account for some 40% of China's GDP. The sector also employs tens of millions of working Chinese, many of whom left their families and homes in rural China in order to find work in the country's rapidly growing cities (resulting in an urban migration of nearly 200 million Chinese since 1995).

As of October, more than 3,600 toy exporters in China alone had gone out of business in 2008, prompting numerous worker protests. Given yesterday's data, we can only expect that number to rise as plant closures spread across industries.

For a country that thrives on order, this presents a serious potential problem. Indeed, more and more reports of riots and unrest in China are leaking into the news. Such protests threaten to undermine China's government and social order before its game-changing domestic stimulus package can even start to work. That, in turn, would reduce China's "stability advantage" over other emerging economies, which heretofore has been one of the main reasons so many western companies have been willing to invest heavily in the country.

The takeaway
If you're invested in China or any of the emerging markets, these events may cause you to rethink your approach. Yet at Motley Fool Global Gains, we believe there continues to be a compelling way to invest in the emerging markets and reap significant long-term profits. That's by harnessing local expertise, limiting your research to well-capitalized, well-managed companies, taking advantage of volatility like this to buy growth cheap, and holding for the long term.

We believe that's the recipe for outstanding long-term returns, even if 2009 proves to be a volatile year. If you'd like to take a look at the rest of our research and recommendations -- including our complete notes from the recent trip to Mexico -- click here to become a Global Gains member free for the next month.

Tim and Nate are Motley Fool Global Gains analysts. Tim owns shares of America Movil. Nate does not own shares of any company mentioned. America Movil and Wal-Mart de Mexico are Global Gains recommendations. The Fool’s disclosure policy works around the world.


Read/Post Comments (5) | Recommend This Article (24)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 11, 2008, at 2:05 PM, HighCap wrote:

    While I agree that the run-up in many commodities was caused by "shortage in supply caused by decades of underinvestment in mines, wells, and refineries." - this explanation doesn't apply very well to ag commodities. The demand is still largely there, but the inventory is not with 30-40 year lows in global ag inventories, and supply is not making up the difference... Something will have to give, and I would foresee a "de-linkage" of ag commodities and petroleum/metals in the near future.

  • Report this Comment On December 11, 2008, at 2:38 PM, jcrash wrote:

    You cannot directly attribute a 2% decline in Chinese exports to reduced demand. I would look at the ongoing credit problems, how those affect letters of credit and how the lack of those affects shipping.

    And, while the bubble may be over - as it was a bubble - when the dollar gets taken out behind the woodshed in the coming months and years, you will be glad you owned something that could insulate you from the depreciating currency.

  • Report this Comment On December 11, 2008, at 7:09 PM, GoNuke wrote:

    The collapse in commodity prices, especially oil, is preventing the oil industry from investing in capacity. They have been burned too often. Oil companies are just going to harvest cash waiting for the economic recovery when demand for oil will rise to the point where investing in more capacity makes sense. They are not investing in capacity now so when the recession ends you can expect oil prices to jump again given that there isn't any cheap oil left to be found.

    Oil stocks will recover faster than you think and they are cheap right now. Oil companies are cash cows right now so they do not need any capital. This time, like last time, investment in capacity will only occur after the prices rise again. Exxon claims it is continuing to explore. They know oil will be worth a lot more soon and they have the cash to maintain their exploration programs.

    Iran is in search of almost $200 billion to invest in its oil infrastructure -where do you suppose they are going to secure that kind of capital? China will continue to expand its capacity but Russia cannot afford to repair its crumbling production capacity and it refuses to let foreigners invest. No the world is not going to take the opportunity to build capacity during this downturn.

  • Report this Comment On December 11, 2008, at 11:26 PM, medgul wrote:

    With out increases in price, there will be very limited investment in exploration, refinery capacity and/or other infrastruture.

    When demand comes back -and it will- prices will go higher than before.

    There will be no/.limited investment in the industry when oil and gas are near/below the cost to find and extract.

    When demand returns, commodity prices will go higher than the highs of 09. -take that to the bankl

  • Report this Comment On December 12, 2008, at 12:04 PM, jrj90620 wrote:

    When the U.S. Dollar crashes all real assets will rise relatively.The mania today is in being long the U.S. Dollar.

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