The Rise of the Chinese Consumer
Letter from the
It's not news
that the world's commodities markets have seen a dramatic upswing in
recent months, with gold climbing past $700 an ounce, and oil and copper
hitting all-time price highs.
But what may be
news to many is the story behind this energized
what's driving commodities, we have to go back to just before the end of
the last millennium and examine an event whose significance was not fully
appreciated at the time.
population reached 6 billion people in October 1999, more than double what
it was in 1960. Here's another way of looking at the rapid pace of human
population growth - it took from the dawn of time until 1927 to get to 2
billion people, and less than 75 years for that number to triple. And in
the past six years or so, we've grown halfway to the 7 billion mark. Six
billion is more than just another round number. It also represents a
"tipping point" for commodities demand accelerated by advances in
technology and economic globalization.
Where do all of
these people live?
together have 2.4 billion
residents, nearly 40 percent of the globe's total. Another 800 million
What do these
seven countries have in common? They are all emerging nations whose
economies have been growing faster than those of the developed world.
Collectively we call these countries the Emerging 7, or
government recently reported that its GDP grew at a 10-percent clip in the
first quarter of 2006, and
's economy is expected to
expand almost 9 percent this year. Nearly all of the E-7 countries - and
many more in the emerging world - have projected 2006 growth rates
surpassing that of the
and the rest of
That growth can
be seen in ambitious construction projects in these
China plans to build 14 express highways, six railways and a dozen new seaport
facilities before 2010.
invests 3.5 percent of
its GDP on power plants, roads and other infrastructure and the government
there is financing "industrial townships" to promote more manufacturing.
, one of the world's
poorest countries, is building hundreds of miles of highways, as well as
schools, water systems and the like.
energy consumption is expected to be 69 percent higher in 2010 than in
2002, according to the Federal Energy Information Administration. That
growth rate is five times higher than the estimate for the
than 15 times higher than
China , in
the midst of a massive infrastructure build-out, used half of the world's
cement and 40 percent of the world's steel last year, according to
But because of
years of low commodity prices and other factors, exploration and
development of these now-coveted resources have not kept pace with global
population and GDP growth. That has created an Economics 101 scenario -
demand is greater than supply, so prices
Not only are
populations growing quickly in many developing and emerging nations, so
are their incomes and their desires for the types of consumer goods that
Westerners have long taken for granted. In the past two decades,
's per-capita GDP has gone
up more than tenfold.
According to the
Boston Consulting Group (BCG), more than 40 percent of the world's
economic GDP growth over the next decade is expected to come in
, Central and
Eastern Europe, and
By 2010, these
"rapidly developing economies" are also expected to account for a third of
sales for multinational corporations, according to
And as those
economies expand, there will be greater demand for oil, gold, minerals and
other natural resources.
CRB Commodity Index has consistently been in record territory in recent
months. It is up roughly double in less than five years. Gold, silver and
platinum prices have risen 100+ percent since early 2001, while zinc, lead
and copper are each up more than 200 percent. For crude oil and natural
gas, the price hike is greater than 300 percent. Despite these impressive
run-ups, we believe that we are still early in the secular bull market for
these and other commodities.
To get some perspective on
this enduring rally, you can look at the "Kuznets Cycle," a cycle of
economic activity that drives commodities
Kuznets, who came up with the concept of GDP, won the 1971 Nobel Prize for
his work to explain infrastructure investment. That work is relevant to
what we're seeing today in emerging nations. Kuznets noticed that roads
and highways, seaports, airports and other infrastructure are built over a
15- to 20-year period. It is a period of strong jobs creation, and once
these pieces are built, the economy is growing and
good example of this is when the
built interstate highways
in the 1950s. This construction work absorbed more than half of the
world's commodities. This is very significant as we look at those emerging
economies that have policies for infrastructure construction and growing
demand for commodities.
rapid growth is driving this secular bull market.
's 3 billion people now consume about 20 million
barrels of oil daily, while 300 million Americans consume 22 million
barrels per day. The difference is that Asia has been growing at 6 percent
per year, twice the
rate. Since 2000, there
have not been enough new discoveries of oil, gas and precious metals to
's demand as they have built
infrastructure. This is the most important reason why we are living with
ever-higher energy prices.
economies are also heavy consumers of copper, whose price has been at
record levels this spring. Copper inventories hit a 30-year low this past
summer, and there have been a host of issues - refining bottlenecks,
various labor issues and rising capital costs - that have kept the market
In the short
term, the biggest domestic risk we see for copper prices is the housing
market. The average house contains some 400 pounds of copper in the form
of wiring, water pipes and appliances, so if home construction were to
slow down dramatically, that could hurt copper prices in the short term.
Long-term, there is still much demand around the world without much
increase in supply.
has been negotiating
energy and minerals deals with South American and African countries as a
way to ensure supplies to feed its economy.
When it comes to
, our investment
team has a simple philosophy: whatever
needs, get long, and whatever they
have as surplus, get it out of the way, because
will just dump it. That
happened with both steel and aluminum.
important to be able to track those supply and demand factors. Copper
prices took off when
stopped selling copper.
Zinc prices were 45 cents a pound last year when
was a net seller, and
they're nearly four times higher since the country became a net buyer.
is also no longer
exporting silver, whose price is at a 25-year
quarters have been volatile, we believe the gold and natural resource
markets will continue to offer exceptional opportunities to investors. We
always remind investors, however, that it's important to diversify between
various asset classes.
best-selling book "Asset Allocation: Balancing Financial Risk," Roger
Gibson recommends an equal allocation between domestic equities,
international equities, fixed-income instruments and hard assets
(commodities, precious metals, real estate, etc.). In his simple model,
investors should limit their hard-assets exposure to 25 percent of their
portfolio in the form of natural resources stocks and mutual funds, and
they should rebalance every year.
Investors funds have turned in exceptional performance over the short
term, as well as over longer periods. Our Global Resources Fund (PSPFX)
won the Lipper Fund Award
in 2006 for consistent
performance over the preceding three years in the natural resources
category as of 12/31/05. The fund ranked #1 out of 74 funds in its
While the wind
is at our back now, it's important to keep in mind that there's always a
risk of severe short-term market corrections. The 1982-2000 bull market
for equities included the spectacular "Black Monday" correction of 1987,
when the Dow Jones Industrial Average fell nearly 23 percent in a single
day. But by mid-1988, stocks had recouped that loss and the bull market
continued for another dozen years, hitting record highs along the
and expectations is important for every investor. Please read the article
"Anticipate Before You Participate," beginning on page 14, for more on how
to use common measurements to benefit your
Investors prides itself on being a reliable source of information for its
shareholders on market cycles, global trends and the benefits of
diversification, mean reversion and rebalancing. We are always trying to
educate our investors about the critical drivers that influence the
various asset classes. We believe performance sells itself, and that it's
more important for investors to have a balanced, timely and insightful
view of what's behind that performance.
CEO and Chief
Investment Officer of
All opinions expressed and data provided are
subject to change without notice. Some of these opinions
may not be appropriate to every investor. Gold funds may
be susceptible to adverse economic, political or regulatory
developments due to concentrating in a single theme. The
price of gold is subject to substantial price fluctuations
over short periods of time and may be affected by unpredicted
international monetary and political policies. We suggest
investing no more than 3% to 5% of your portfolio in gold
or gold stocks. The AMEX Gold Bugs Index (HUI) is a modified
equal-dollar weighted index of companies involved in major
gold mining. The S&P 500 Stock Index is a widely recognized
capitalization-weighted index of 500 common stock prices
in U.S. companies.