Is this man the best macroeconomic indicator in the world?

If you think stocks are cheap, you should take a look at commodities!

This ratio of commodity prices to stocks is near an all-time low.

Source: Tim Verheyen, Twitter

That tends to happen when financial orders have run their course. Which doesn’t end well.

Let’s explore why commodities make comebacks during turmoil.

Commodities are tough to figure out because they’re priced in financial markets, but not of financial markets in the same way that stocks, bonds and derivatives are. They’re used in the real economy, which is subject to the booms and busts of the financial system too.

But commodities can be set apart in a particular way. They’re real things that, if you own them and have them in your hand, don’t rely on counterparties. They’re non-financial in that sense.

People who hedged for a financial crisis with Lehman Brothers as their counterparty can explain what counterparty risk is. Or investors in funds which have been gated. At the turn of the decade – four months ago – when my colleague Boaz Shoshan asked each editor at Southbank Investment Research about the biggest risk to financial markets, my answer was counterparty risk. Well, commodities are a rare way out for some investors because they’re real.

When the price of financial assets is out of whack relative to commodities, it suggests that the financialisation and trust in the economy are running hot. People are willing to believe in promises of repayment, future earnings and investing expertise. Which happens shortly before things go wrong in financial markets. At that point, you’re better off owning things which don’t have counterparties – which are real.

Not that you should go buying lumps of copper. Or stripping church roofs, as people do during commodity bull markets. At one point during the last commodity boom, China had a spate of manhole cover thefts which wreaked havoc when combined with the spread of smartphones.

In eras where commodities boom, relative to stocks, real stuff matters more than financial promises, predictions of profits and future tech revolutions.

Given the ratio above, that may well be upon us. Which suggests a turning point in financial markets too.

What should you do to take advantage of a commodity bull market relative to stocks? Well, you could buy commodity stocks. They’re certainly beaten down right now…

But perhaps you should consider moving to Australia to benefit from the coming commodity boom. That’s what Southbank Investment Research’s founder did in the early 2000s. Dan Denning helped found our Aussie sister company back then, and hired me years later in 2009.

Australia boomed on the commodity bull market back then. The Aussie dollar took off too, reaching well above parity to the US dollar. High school students could earn six-figure salaries by driving trucks bigger than a house in the middle of nowhere, two weeks on, two weeks off.

When the commodity market turned and the financialisation of everything took off again, leaving commodities in the dust, Dan moved to London to set up Southbank Investment Research. The UK, as a global financial centre, stood to benefit from the age of fintech and unicorns.

Dan spent last year travelling through the US, trying to catch up with all of his very extensive extended family, and looking for what he called “bolt holes”. These are places to retreat to when the financial markets and social stability hit the fan. So he timed that well too… Anyone who followed his advice is sitting pretty right now. Compared to me in London, anyway…

But now Dan is back in Australia. At least, he was the last time I checked. He seems to have stuck around after a holiday. Which begs the question, is another commodity super cycle underway? Are commodities about to boom again?

I think so, sometime soon. If you think about it, a pandemic which shuts down the global economy is a rather good time to buy into commodity stocks. They couldn’t face anything worse in the short run. But when things return to normal, there will be a supply shortage.

The struggle is to find the stocks that can survive the initial turmoil. But the criteria for that could be simple – companies without debt, or minimal debt.

But there’s a caveat, which the chart above hides, but which the tweet it came from reveals.

Commodities can surge in price relative to stocks during inflationary periods too. When real stuff gets real expensive because money is losing its value. Promises of future interest payments or new tech are suddenly not very enticing.

Commodities aren’t just counterparty risk free, depending on how you own them. They’re also good at protecting from inflation. Because they’re real stuff.

If inflation kicks off now, governments will have to accelerate these plans, rutting the financial system into the same lockdown as they have the economy already.

Then the stockmarket will stop crashing. Because it won’t be open any more.

At which point owning commodities outside the financial system becomes the best investment. That’s why they’re included in our “Escaping the Financial System, A Field Guide” report.

Nick Hubble
Editor, Southbank Investment Research

Category: Commodities

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