for Diminishing Resources
June 21, 2011
In his most recent commentary, Jeremy Grantham became one of the first mainstream investment professionals to publicly forecast a world economy threatened by diminishing natural resources. A survey of our readers showed that an overwhelming majority agree with Grantham’s views. But constructing a portfolio positioned to capitalize on those themes is exceedingly difficult.
Grantham is co-founder and chief investment strategist of the Boston-based global manager Grantham, Mayo, Van Otterloo & Co. He is widely recognized for his prescience in identifying asset class bubbles and long-term investment trends.
In the first part of his most recent commentary, published in April, Grantham articulated his view of diminishing resources. “The world is using up its natural resources at an alarming rate, and this has caused a permanent shift in their value,” he wrote. “We all need to adjust our behavior to this new environment. It would help if we did it quickly.”
I’ll summarize Grantham’s views and the results of our readership survey, which was conducted over the last few weeks. Then I will look at the various ways one might invest based on Grantham’s outlook.
The days of abundant resources are over
Grantham has written about diminishing resources in the past, but his April commentary was by far his most exhaustive review of the subject. A combination of diminishing resources and a growing population has permanently reversed a trend of decreasing commodity prices, according to Grantham.
Commodity prices declined over the 20th century at a 1.2% annual rate, he wrote, because the marginal cost of production was less than the gains in productivity, given the supply and demand characteristics across markets for natural resources. “But this was just an accident,” Grantham warned. Indeed, over the last eight years, he said the price declines of the previous 100 years were reversed.
Now, the world faces a “paradigm shift” of higher prices for resources, according to Grantham, as the demand for resources will outstrip their supply. For example, the rate of oil production is peaking on a worldwide basis (it peaked in the US in the 1970s), and the marginal cost of production is rising.
It’s not just peak oil, though — all peak resources threaten economic growth, he wrote. Grantham’s assessment of a paradigm shift in prices was based an equally weighted basket of 33 industrial and agricultural commodities.
Copper and iron ore are exhibiting “peak” characteristics. Agricultural commodities are as well, because most of the increase in crop production has come at the expense of increased use of fertilizers, and fertilizer use is constrained by, among other things, diminished resources such as potash and phosphates.
The primary culprit driving the paradigm shift is growth in emerging markets, particularly China, he wrote. China’s high level of capital spending is upsetting the balance of global supply and demand. China uses 53.2% of the world’s share of cement, 47.7% of its iron ore, and 46.9% of its coals.
The supply-and-demand imbalances driving prices higher are a permanent, long-term trend, according to Grantham.
Grantham explained why he has been one of very few in the investment industry to embrace peak resources. Human beings are naturally optimistic, he wrote, and it takes a strong contrarian discipline to advocate a view that will lead to lower economic growth and, hence, muted returns in the capital markets.
Grantham cited two factors that, in the short term, could cause commodity prices to decline. Although he said weather will be instable due to global warming, weather patterns could be more favorable in the next year, decreasing agricultural prices. China also faces a number of challenges that could slow its growth. There is an 80% chance that commodity prices could decline significantly in the short term if one of those events were to occur, he wrote.
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