Hogsback on the brave new (high-priced) world of Jeremy Grantham

THE earth wobbled this week for Hogsback, and not in an earthquake sort of way. It wobbled because he made two discoveries. Firstly, that China consumes almost 50% of the world’s coal. Secondly, that one of the great “bears” of world resources morphed into a “bull”.

Tim Treadgold

The coal consumption number is probably known to readers of ILN, although it was a surprise to see it used in an argument to claim that the global resources boom might have just begun.

Think about that for a tick. Imagine that everything which has happened over the past 10 years was nothing more than a game of “catch-up”. That the price rises enjoyed by most of the world’s important commodities was simply wiping out the price declines of the previous 100 years.

It might sound far-fetched, but when you take the next step and understand the background of the man who said it, the importance of what’s happening becomes more interesting, and more believable.

Jeremy Grantham is co-founder of a US funds management business called GMO (Grantham May Van Otterloo) which manages more than $US100 billion of other people’s money – and he is also a very big “bear” (or was).

Grantham made his name for correctly placing investment bets against assets which enjoyed excess price rises. His catch phrase was “revert to mean”, a fancy way of saying that everything, over time, reverts back to its long-term price trend.

Last year he angered every property investor in Australia by claiming that house prices in Oz where 50% above their long-term trend, and would have to fall back by that amount, or stagnate for a decade to let inflation do its work.

Commodities, including coal, have suddenly become a different kettle of fish for the man who has always relied on statistical evidence to support his predictions –investment decisions that have been proven correct.

“Time to wake up” are the first words of his latest quarterly newsletter. “Days of abundant resources and falling prices are over forever”, makes up the rest of the headline.

What’s caused Grantham to admit that commodities are different is a realisation that the world’s population is outstripping the available supply of raw materials.

In some ways this is a modern day version of the argument first put by Thomas Malthus, the British economist who argued 200 years ago that the world’s population was growing too rapidly and mass starvation was just around the corner.

For much of the past two centuries Malthus has been proved wrong. Grantham now thinks he was onto a winning argument, and the reason he has changed his tune is because of China – with India and the rest of heavily populated Asia following.

Essentially, Grantham has recognised that Chinese consumption (53.2% of the world’s cement, 47.7% of its iron ore and 46.9% of its coal – to name just three commodities) is placing an unbearable strain on supply and that prices must continue rising.

He demonstrates what has happened recently by referring to a price index that his firm has devised. The GMO Commodity Index tracks the price of 33 major commodities, including coal, copper, wheat, wool, sugar, lead, lard, and pepper (which is an interesting inclusion).

The index starts in January 1900, and after allowing for inflation and the odd war and depression, it shows a steady decline with increasing costs of around 2% a year offset by increasing annual productivity of 3.2%.

Boiled down, between 1902 and 2002 the GMO index fell by 70% -- a number which might surprise some readers although Hogsback remembers back in the 1970s being taught that commodity prices were in long-term decline.

Now comes the good bit for everyone in the commodities game. Between 2002 and today all of that 70% decline has been wiped out with Grantham using a most unfortunate expression to describe what’s happened. He calls it a “paradigm shift”, triggering memories of the nonsense spouted in the tech-boom of the 1990s.

What next? Now that 100 years of bad news about falling commodity prices has been eliminated, where do we go?

In one word; upward. Grantham reckons that his lifetime argument of all asset classes reverting to their mean price trend has been broken.

Not only is he tipping higher prices for all commodities as the world population demands more raw materials, especially energy, but he is re-directing part of the portfolio he manages into “stuff in the ground”

Grantham’s thoughts are those of one man. But he is a man with runs on the board, and he wears the scars of his critics for sticking to his 50-year revert-to-mean mantra – during which time he was right.

There is a fair chance that he will be right again even if it means disappointing his disciples by acknowledging that his new speciality will be “regret minimisation”

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