Despite the pull-back in prices over the last couple weeks, most key commodities have at least reached their pre-2008 highs. From oil to iron ore to wheat, the run-up that began in the late 1990s is continuing.
It is becoming increasingly difficult to argue that this trend is something temporary, that commodity prices will revert to their century-long gradual decline. Instead, the evidence suggests that for the first time since the end of the 19th Century growth in demand is rising ahead of the world’s ability to increase supply. If true, this change will have profound consequences on the distribution of income globally.
There has been considerable debate about the causes of the nearly decade-and-a-half-long bull run in commodities. One element is clearly a growing aversion to dollars. Concern about inflation and the debasement of the US dollar has led investors to increase allocations to commodities.
This is true of everyone from retail investors to the University of Texas Investment Management Co., the US’s second-biggest university endowment that last month took delivery of $992 million worth of gold bars.
But alongside this hedging play there are also clearly real factors at work. The single greatest driver of this demand is growth in emerging markets. The five-year period from 2003-2007 was one of the fastest periods of global economic growth in history – GDP increased by an average of 4.7 percent a year compared to 3.4 percent over the previous 30 years, and an average of about 3 percent over the previous century.
According to the IMF, after the 2009 downturn, the world is going straight back to those high growth rates. From 2010-2016 they expect growth of 4.6 percent. That growth is despite the structural headwinds facing the US, Europe and Japan – in other words, emerging markets are now generating high global growth even without the demand growth in the developed world. High growth among the five billion people outside of the developed world is now self-sustaining.
Growth to Continue
Given the low starting point, there is no reason why this trend can’t continue for several more decades. Indeed, if financial markets are a little bit more imaginative than simply allocating global savings into the US, growth may actually increase further. This kind of demand growth will put tremendous pressure on commodity markets.
For Russia, of course, this presents a major opportunity. We’re the world’s biggest exporter of oil and gas. We have 10 percent of the world’s nickel reserves, 44 percent of its palladium, 23 percent of its timber and 15 percent of fresh water. And, with little fanfare, we have become a net exporter of agricultural products in recent years. Our commodities production is causing a wealth effect that drives domestic consumption. It is up to us to handle this huge economic opportunity effectively.
For investors in Russia this means that revenue growth will likely be sustained for some time to come. According to IMF numbers, dollar gross domestic product is expected to double from $1.6 trillion to $3.2 trillion by 2016. The trickle-down impact in Russia is surprisingly strong.
It has been banks, retail and consumer companies which have tended to benefit most from strong commodity prices in the past. Given that Russia is already trading at low valuation multiples relative to its emerging market peers, now is a good entry point on any kind of medium-term perspective.
Of course, natural resource wealth is not enough on its own. Russia has still got some way to go to put the institutions in place to make sure that the commodities boost is not frittered away. The tricky thing about Russia is that there are very real risks, political and otherwise. Particularly international investors have, occasionally, had a tough time here.
In Russian, we refer to risks as “underwater stones”, the dangerous rocks lurking below the water’s surface that can sink a ship – or a stock portfolio. But the reality is that these underwater stones are never far below the surface.
Responsible local investors are well placed to avoid the Russia-specific risks and benefit from the global trends. There are certain rules of the game – nautical charts, if you will – that let you know when the water is getting shallow and you are better off making allocations elsewhere.
The author is Dimitri Kryukov, chief investment officer of Verno Capital.