Benefit From Increasing Demand

Massive construction activity in China is creating new demand for commodities at levels that we have never seen before. No-one knows when the current commodity demand cycle from China will end but what we do know is that it is not likely to end anytime soon. China’s growth is unprecedented, no economy in the world has grown at the rate that China has over the past 30 years.

Consider this, China’s average GDP growth rate over the past 30 years is 10%, with peaks as high as 15.2% in 1980. Before 1978 annual GDP averaged 6% a year. Economic reform and fundamental changes to international trade and private business ownership kick-started the boom. 20% of the world’s population lives in China, just over 1.3 billion people, and this being achieved after the introduction of the ‘one child policy’ in 1979. This freight train of growth brings with it many benefits for the Chinese people. The growth creates more jobs and as a result improved living standards, better housing and utility services, and better quality basic items such as food and clothing. Nearly half of the Chinese people are regarded as ‘middle-class’ by their standards.

Along with all these developments comes higher and higher demand for commodities and as futures traders the fundamental changes occurring in worldwide commodity demand is a trading and investment opportunity the like of which has never been seen before.  The cost of food is outpacing wage growth and the insatiable demand for food is reflected in the futures markets. Corn, sugar and coffee prices have risen by more than 100% in the past year.

In addition, the Chinese population is on the move, away from the farms and into the cities. Such urbanisation further increases demand for household goods and services.
Right now, we cannot produce, make or create enough food, energy or base metals to satisfy current demand. How then are we going to satisfy demand when India, Brazil and other emerging economies do the same as China has done over the past 10 years? The answer is that we know there will be a lag before new production and supply chains are opened up in all commodity sectors and the increased supply capacity comes on line. Until that time commodity prices will remain elevated. For the futures trader this presents a very profitable trading opportunity and until the balance between supply and demand is re-established prices will trend higher over time.

Commodity supply is not like a water tap, we can’t just turn on the tap and produce more, there will be decades of adjustment and development. While we will see desertification in some areas areound the world the opposite, oasification or humidification, is occurring in others. While we see some capacity problems in the crude oil market during periods of high demand, we are seeing alternatives being developed such as ethanol and access to natural gas resources.

Never underestimate the capacity of the human spirit to solve problems and engineer alternatives to satisfy human needs.

The problem we see is the amount of lead time needed to get the alternative or substitute end product to market and this creates an opportunity for commodity traders. Not only can we trade the commodity futures markets in a variety of ways, but we can also invest in forward thinking enterprises that see the opportunities in the commodity markets and meet insatiable demand with innovative processes and product developments.

Ethanol is such a development. The largest use for ethanol is as a fuel with the two largest producers being Brazil and the U.S.A. Brazil uses sugar as the feed for ethanol production and the U.S. uses corn. Ethanol production was spurred in recent years by a spike in the price of crude oil as the world searched for alternatives in the absence of any spare capacity in the crude oil market.

Other developments include expansion of the natural gas industry and the development of agriculture industries in undeveloped countries. A prime example is the current proposal on the table in Australia right now to build dams in the Northern Territory and create another ‘food bowl’ for Australia in areas that would never have been considered before. Australia is no different from the rest of the world, our population is growing and we need to produce more to satisfy demand growth for basic commodities such as food.

The current correction in commodity prices is not a reflection of price balance in the commodity markets but rather the difficulties in Europe. Sovereign debt risk from countries like Greece worries traders and traders are reluctant to take positions while potential negative outcomes from Europe are still possible. While there is the possibility for Europe to pull the world back into recession Europe will be a drag on demand growth for commodities and we may see a long-term trend correction in the commodity markets as a result and that will be the ideal time to re-enter or add to commodity futures holdings.

Commodity prices will correct as traders fret over Europe and at the same time emerging countries will be eyeing off cheaper commodity prices. At some stage the need to satisfy demand for a broad range of commodities will force big users like China to start buying to shore up forward supply.

Make no mistake about the severity of the European debt crisis; it has the potential to hurt the US in a big way. US banks have exposure to the risks of the European financial system but an estimate of the level of risk varies and only time will tell how much exposure the US banks carry.

Do not underestimate the capacity of the authorities to successfully negotiate the crisis and avoid another recession. We at Jennings Futures Trader think that the worst case scenario is already priced in to the market and even today’s downgrading of Italy’s credit rating to A from A+ with a negative outlook was anticipated.

Europe is a problem, China is a growth engine and we will explore all that and more in the weeks ahead in the Jennings Futures Trader Commodity reports.