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Reginald W. Ogden

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Gold and Commodities

By Reginald W. Ogden      Printer Friendly Version
Aug 4 2008 10:25AM


In a world of rapid economic growth where statistics on trade in emerging countries are either unreliable or inaccurate or in some cases do not exist at all, one way to accurately gauge the health of the world economy is through the health and stress placed on its main arteries – i.e. seaborne commodity freight rates. The Baltic Dry Index has often operated as a reliable indicator of commodity prices. The index foretold the surge in metal prices that occurred in mid 2003 and continued into 2004, which led to shipping freight stocks hitting all-time highs. The index stood at a low of 843 in November, 2001 and peaked in February, 2004 at 5081 – a gain of 500%. The index was set up in 1985 in order to create an effective futures hedging mechanism for "freight risk" in the dry cargo market. In shipping, the short-run supply of freighters is not as important as the demand from global industry, which is the determining factor in setting freight rates. In 2002 alone, many of the freight rates increased two to four times as iron ore, coal, grains and the steel trade went into high gear.

From a February low of 2000 on the BFI in 2006 the index broke out again before peaking at close to 11,000 in October 2007 primarily on a surge of demand for coal and iron ore.

Just as the growth of the US as an industrial power caused a commodity boom in the 19th century and as Japan did in the 1960’s the BRIC countries (Brazil, Russia, India and China) have caused a Super Cycle to occur since 2001.


Mining stocks are equities as well as a call on metal prices and hence are subject to general equity market influences, spot metal prices, metal supply/demand changes and mining company earnings. These two major influences are not always in sync with each other.

In the long run, the mining index correlates 76% to the Dow and 85% to metals consumption. Historically, mining stocks have bottomed out at the same time as the Dow, regardless of what happens to metal prices.

Some of the largest percentage moves have occurred with no assistance from metal prices – e.g.1970 to 1971, 1974 to 1975, late 1980 and between 1982 and 1983. Conversely, huge metal price increases were registered from very late 1972 through to the middle of 1974, while mining stocks faltered. There are two primary scenarios when mining stocks peak:

  • Between major tops in the Dow and lagging metal prices – e.g. 1969, 1973 and 1976 to 1977.
  • When the Dow and commodities experience simultaneous tops – e.g.1966 and early 1980.

Throughout the1980s and1990s, demand growth for basic commodities, including metals, had been slow, which in turn makes inventory levels significant. It takes a long time to draw down inventory stocks to a critical level. Exponential price explosions tend to come late in the business cycle, causing metals and metal stocks to lag the general market equities.

Not until inventories decline below10 weeks of demand is there much effect on metal prices. Below 10 weeks, price moves can be substantial and fast. In this respect, it is unlike oil or gasoline, where constraints on storage and inventories cause short-term price volatility. Only when a single company controls an industry, do prices stabilize and follow costs of production – e.g. DeBeers and diamonds.

The rapid development of continental India and China has transformed base metals and most commodities into growth sectors. The days when the U.S. starts off an economic recovery and the rest of the world follows is rapidly coming to a close.


Complex trading instruments for trading commodities existed long before equity shares were ever traded. Many of the trading practices for dealing in commodities, such as futures, were carried directly over to the trading of equities. For commodities, there was an active secondary market involving paper titles long before the first common share equities were created.

Jiang Yang, CEO of the Shanghai Futures Exchange, claims grain futures existed in China during the Song dynasty 800 years ago.

Many of the current futures exchanges began life as primarily agricultural product markets to even out seasonal fluctuations for farmers and grain dealers. In London the streets around the exchange still bear the names of the commodities such as Pig Lane. Likewise the New York Mercantile Exchange began life as the Butter and Cheese Exchange.


There is a general consensus amongst commodity and economic analysts that the world is going through the early phases of a long-term secular bull market for commodities.

Over the past 20 year secular bear market for commodities there has always been a short-term bull market for two or three commodities each year based on climate, as well as sudden supply shortages due to political events and crises. In the early phases of the current secular bull market, those commodities that China had in relative abundance, such as magnesium, tungsten, thermal coal and zinc, did not join in the price appreciation and then as economic growth in both India and China accelerated the bull market spread to almost all commodities.

The last secular bear market in commodities covered the 26-year period from 1973 through to March, 1999. The collapse of the Asian Tiger economies coincided with the secular deflationary low for leading commodities and marked the start of what portends to be a long-term secular commodity bull market.

The growth of the two most heavily populated countries on earth will provide the impetus for a steady upward staircase move in gold prices, especially in U.S. dollar terms over the next 10 to 12 years. If current commodity trends persist, oil and gold could regain the previous strong correlation they held with each other in the 1970s and Demand/Pull inflation could easily turn into Cost/Push inflation, which would be bullish for gold and precious metals.

Ernst and Young in a recent report on commodities observed that most mining analysts have erred dramatically on metal price forecasts, consistently expecting a return to historical cyclical declines and unwilling to stray too far from the comfort zone of historical long term trends. As a result many mining securities remain cheap on a historical earnings basis prompting a rash of mergers and acquisitions by majors.

Since 2005 overall analysts metal price estimates have erred anywhere from 20 to 200 percent.


According to Gary Gorton and Geert Rouwenhorst of the Universities of Pennsylvania and Yale, for the 45 years to 2004, commodities futures have had roughly the same return as stocks, but with less risk and provided a better hedge against inflation than stocks or bonds.

The publication of the report which was based on the rollover of commodity futures contracts led to a surge in institutional investment in commodities.

Likewise commodity index holders are investors not hoarders. Harvard University Endowment Fund has been investing in commodities with excellent results for over ten years. Although the media regards this as speculation many institutions operate a “buy and hold? strategy rolling over positions as the futures expire. For the five years to June 30, 2004, commodities showed a 16% return per annum, while the S&P showed a return of only 2.2% per annum during the same period.

Traders often characterize the commodities market as a collection of distinct markets with each fluctuating according to its own demand and supply fundamentals. Since 2001 there has been strong evidence of a commonality across most commodity markets. While in all commodity markets history shows that demand pushes prices up supply brings them down. Major countries and industry players now are investing across all commodities to ensure future supplies for the long haul.


Just as lotteries have been described as voluntary tax on the poor commodities trading has been called a voluntary tax on the rich. Many commodities speculators do not survive and few thrive.


- Tom Whelan, Mining Analyst, Ernst and Young.

“In the past century mining cycles have often been caused by specific events.?

Recently a single event, the flooding of coal fields in Australia, caused a sharp hyperbolic rise in coal contract prices. Weak prices in the 1990’s of many commodities were due to the collapse of the Soviet Union and the release of stockpiles of commodities to raise foreign currency.

Reginald W. Ogden
Canaccord Capital Corp.



This article is solely the work of the author for the private information of readers. Although the author is a registered investment advisor at Canaccord Capital Corporation ("Canaccord Capital"), this is not an official publication of Canaccord Capital and the author is not a Canaccord Capital analyst. The views (including any recommendations) expressed in this article are those of the author alone, and are not necessarily those of Canaccord Capital.

The information contained in this article is drawn from sources believed to be reliable, but the accuracy and completeness of the information is not guaranteed, nor in providing it does the author or Canaccord Capital assume any liability. This information is given as of the date appearing on the article, and neither the author nor Canaccord Capital assume any obligation to update the information or advise on further developments relating to the information provided herein. This article is intended for distribution in those jurisdictions where both the author and Canaccord Capital are registered to do business in securities.  Any distribution or dissemination of this article in any other jurisdiction is strictly prohibited. The holdings of the author, Canaccord Capital, its affiliated companies and holdings of their respective directors, officers and employees and companies with which they are associated may, from time to time, include the securities mentioned in this article.