I always look forward to reading Jeremy Grantham’s quarterly letters. The latest one however left me underwhelmed and puzzled. In it (see below) he makes a case that the commodity cycle that we are seeing is different than all the previous ones. It is a very gloomy outlook full of dire warnings about what may come if humanity continues its hellbent pursuit of growth.
- The rise in population, the ten-fold increase in wealth in developed countries, and the current explosive growth in developing countries have eaten rapidly into our ﬁ nite resources of hydrocarbons and metals, fertilizer, available land, and water.
- Now, despite a massive increase in fertilizer use, the growth in crop yields per acre has declined from 3.5% in the 1960s to 1.2% today. There is little productive new land to bring on and, as people get richer, they eat more grain-intensive meat. Because the population continues to grow at over 1%, there is little safety margin.
- The problems of compounding growth in the face of ﬁ nite resources are not easily understood by optimistic, short-term-oriented, and relatively innumerate humans (especially the political variety).
- The fact is that no compound growth is sustainable. If we maintain our desperate focus on growth, we will run out of everything and crash. We must substitute qualitative growth for quantitative growth.
- But Mrs. Market is helping, and right now she is sending us the Mother of all price signals. 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.
I don’t mean to be a Pollyanna but I find it difficult to agree with Grantham’s conclusion that this is a secular shift, “forever”, never to be undone. Yes, of course we have serious challenges ahead of us. There is no question of that. But in contrast to Grantham, I see the current cycle as just that, another cycle.
If pressed I can offer no evidence for that other than the historical pattern of commodities. In case you missed it, I wrote a commentary on this a few weeks ago: The Commodity Supercycle – Is this time different?
Ultimately, the assumption that underlies such a position is faith in humanities will and creativity for survival. At each stage of our advancing civilization we have overcome great odds and adversities. Each of course was different in its own way. But somehow, we made the necessary advancements to adapt.
Far be it from me to criticize one of the luminaries of the investment world at the top of his game. I can’t help but imagine if Grantham had lived during the turn of the century, would he be writing about and charting the dire shortage of whale oil and the devastating consequences that this spells for our society?
In the long run, I don’t think it is naive to be optimistic or to be “long” human ingenuity as Dylan Grice put it in a research note from late last year:
Why should commodities provide investors with a real risk premium? Shouldn’t prices actually decline in real terms over time? A bushel of wheat, a lump of iron-ore or an ingot of silver today is identical to a bushel of wheat, lump of iron-ore or ingot of silver produced one thousand years ago. The only difference is that they’re generally cheaper to produce because over time, human innovation has lowered the cost of production. When you buy commodities, you’re selling human ingenuity.
Past performance is no guarantee of future results, obviously, but human ingenuity has a good track record of overcoming nature’s constraints so far. A commodity bull market is really just a bottleneck and as a species we’ve succeeded in bottleneck removal. Historically, most bull markets have ended up where they started.
Why bet against human ingenuity by buying physical commodities when you can bet on it by investing in the enterprises whose task is to remove the bottlenecks and lower commodity prices?
Grice showed charts to prove his main point main point that commodities are meant to be traded, not held in a portfolio passively for the long term. In this chart he compared owning commodities as an asset class with various bond indexes and the S&P 500 index (equities):
To show the clear cycle of boom and bust in commodities Grice showed this very long term chart:
Grantham is one of the greatest students and masters of financial cycles. Perched atop this knowledge, it affords him a very long term perspective from which to spot market bubbles and also, after the fact to find buy opportunities (see: Investing When Terrified to read how Grantham turned positive on the markets in March 2009). In fact, he received much scorn when he adamantly called the real estate in Australia and the UK as “bubbles”.
So I’m confused to see a master like him say the most dangerous words in investing, “This time it is different”.
Perhaps history will show me to be a naive fool but I believe that just as we are faced with serious challenges, awe inspiring potentials also exist that will not only answer today’s challenges but relegate them to the pages of textbooks just as our children now learn about windmills, whale-oil and penicillin. New creative individuals, companies and initiatives will rise up to provide these solutions and as their collective energies propel civilization forward, financial markets will provide the capital they require and benefit from the value they create.
Below you’ll find the full quarterly letter from Jeremy Grantham, “Time to Wake Up: Days of Abundant Resources and Falling Prices Are Over Forever“: