I spoke on the panel of a conference that backed into a keynote address by Dennis Gartman. I thought he had a lot of interesting things to say, a lot of which I agreed with. The basic theme of his talk – and this was an investing in inflation conference – was that commodities are not an asset class. He called the notion that they are “crap” and warned those hedging inflation using commodities as a primary vehicle would get whipsawed by the timeless and excruciating bull and bear markets that dominate this market.
Gartman’s contention about commodities is interesting given the preceding post from Fred Sheehan on the secular bull market in crude. I also believe crude is in a secular bull market and I outlined it several months ago using the soft peak argument that Fred is pointing to. But Gartman did make good points that I want to bring to bear on the discussion.
I would put his argument into five broad categories.
- Commodities are notoriously volatile. During my panel, one speaker noted that his firm AllianceBernstein had done serious leg work in getting price data back to the 1890s on commodity prices. And what they found was a correlation between commodity prices and the rate of change in inflation, meaning that, historically, commodities have been a decent hedge for rising inflation. Gartman, on the other hand, stressed the fact that commodities moved up and down violently and suggested – based on his extensive experience as a commodities economist, commodities floor trader and market observer – that commodities were a speculative arena, not at all suited to be an alternative asset class in mainstream portfolios.
- Technology is having an impact on oil exploration. The second plank of Gartman’s argument was that technology was being used to positive effect in the commodities arena. He cited the massive decline in the rate of dry well drilling and the advent of horizontal drilling as examples. And he additionally cited a statistic of proved reserves in the United States quadrupling in the last 40 years as prima facie evidence of the impact of technology. His contention is that, while he was being told in 1968 in college that the US would run out of oil by this time, in fact proved reserves had quadrupled and the technology to extract oil and natural gas could make the US a net exporter of gas in the not too distant future.
- Technology is having an impact on supply. Gartman gave the example of the drought which crushed Q2 GDP numbers as proof that technology means better yields. He said that farmers are re-assessing the damage post-harvest and finding that they have much better crop yields than they would have anticipated given the drought. Some examples of technology’s impact: we have 99% fewer farmers than at the turn of the 20th century and can yield 15 times as much product per acre. Crop yields have quadrupled in the last forty years and he expects them to rise even more going forward.
- Technology is having an impact on oil demand. Gartman also cited the 1965 Pontiac he bought that, with an 11 miles to the gallon usage, was considered a fuel efficient car when he got it in the mid-1960s. Today his Jaguar, a supposed gas guzzler, gets 29 miles to the gallon and the average car age being 11.7 years in the US means that when we do upgrade vehicles, we do so to much more fuel efficient ones. In his view, this will put a fundamental downward bias on per capita oil consumption in the developed economies. He did not mention China or India or the growth in consumption there. And since It is clear that’s where the increase in demand is coming from, I see this part of the argument as weak.
- Demand is having an impact on supply. Gartman said that when he was the Chief Economist of Cotton Inc in the early 1970s, there were 10,000 acres in cultivation in four states in the deep south around North Carolina where he was based. This was an area known for cotton. Yet, today, in Suffolk County, Virginia, where he is now based, there are 100,000 acres under production. That tells you why prices rise and fall in massive secular waves – as supply responds to demand.
Bottom line: In Gartman’s view, this is commodity bearish. He sees prices selling off. In fact, he believes that the huge oil finds in North America will make North America a net exporter of oil in the next few years. From a geopolitical perspective it would be huge, especially if the US itself becomes a net exporter down the line as Gartman predicts.
I found the overall argument Gartman was making compelling for agricultural commodities but less so for oil, where the additional reserves have come at price levels that put a floor under the price of oil. Moreover, all of the additional demand is coming from emerging markets. When the Chinese economy slows dramatically, I will be a believer in the cyclical oil price decline. And if that slowdown is a secular one, then yes, the price of oil will see a secular decline. But not to the price levels of the late 1990s or inflation-adjusted pre-1973 oil shock levels. The days of cheap oil are over. That said, a Chinese slowdown could also mean that North America does indeed regain net crude exporter status and that has all the geopolitical implications that Gartman says it does.
The conversation on oil led into the reserve currency status of the US dollar. Here, Gartman asked which currency had any chance of replacing the US dollar as the world’s reserve currency. His view is that a hegemony like the US with the world’s biggest naval and overall military power would always be the reserve currency because the projection of military power would entrench its economic power. And given the fact that no nation can come close on this score, Gartman believes that US dollar reserve status is assured.
I agree with this line of thinking. But I would also say that all the other currencies are completely inappropriate replacements. Sterling supports an economy that’s too small as does the Swiss Franc, and the Australian and Canadian dollars. The euro is a basket case. And the Chinese Yuan isn’t even a fully convertible currency. China doesn’t have developed foreign exchange markets. Where would the demand for Yuan use come from? The push for Yuan status via China’s bilateral trade agreements to use Yuan will take decades to create that kind of demand. As I said a few weeks ago on RT, the hyperinflationists are fundamentally misguided if they really think hyperinflation can embed itself when the US dollar is the world’s reserve currency. It won’t happen.
Finally, there’s gold. Gartman sees gold going up and to the right and there’s nothing on the horizon that seems to undermine that trend. There are no lower lows or trend breaks or death crosses to worry about now. My view is that, as long as currency and even government bonds, including longer duration ones, are sporting negative real yields, there is no opportunity cost to holding gold and other precious metals as an asset class. If you think of gold and precious metals as currency, then they should retain value better in periods of financial repression that erode the real value of fixed income financial assets and currency equivalents. In my view, that’s the reason to look to real assets as a store of value. If you think the world’s central banks are going to be keeping real yields low or negative, expect real assets to benefit. For subscribers, see my thoughts in my last post on negative real yields and inflation for a fuller discussion.