Fasten Your Seat Belts for the Next Commodity Boom

It’s easy to see why investors hate commodities right now. The chart below says it all…

The Commodity Research Bureau’s (CRB) Commodity Index has gone “round trip” since 2009, while the S&P 500 Index has tripled. But a contrarian might look at the sell-off in this space and see bargains begging to be snatched up.

I’m not saying every commodity stock is undervalued. Those with too much debt and not enough cash flow could still be headed for the wood chipper. But select stocks and commodities could do very well. That’s because there are powerful forces coming into play that should send commodities much higher.

Let’s look at three of those forces today…

Force No. 1: Cyclical Bottom in Commodities

Sharp price declines in many commodities have put supply and demand much closer to equilibrium. New mine plans are shelved and multibillion-dollar oil projects are put off until prices recover.

This puts a crimp in future supply. For example, gold prices have been in bear market territory since 2011; no one is starting new gold mines. And mining capital expenditure spending has been cut in half since 2012. As a result, gold supply is expected to peak this year and fall next year.

We’re hearing the same reports in the energy space as OPEC and the U.S. battle it out to see who will be the surviving low-cost producer. The taps at existing projects are opened wide, but new projects are put on the shelf.

Meanwhile, after years of low prices and producer shakeouts, agriculture prices are finally starting to perk up. And so we’re seeing an interesting development in the CRB Index, a basket of commodity prices…

Commodities are cyclical, and it sure looks like commodities are bottoming now. In the past, these bottoming formations have led to superb gains… 71% in 1999-2000, 218% in 2002-2008 and 85% in 2009-2011. Of course, many individual commodities and commodity-focused stocks delivered even larger gains. This time, who knows?

Force No. 2: Urbanization Has a Long Way to Go

Once a new cyclical bull market in commodities kicks into gear, it is likely to develop into a very powerful, long-term move.

That’s because the world’s two most populous nations, India and China, have a long way to go when it comes to urbanization. This factor is important because urbanization drives demand for steel, aluminum, copper, oil and all sorts of commodities.

As a rule of thumb, a country becomes “fully urbanized” when 75% of the populace lives in or near a city. For perspective, the urban populations of the U.S. and Canada are both 81%.

But China and India are far away from that number. The World Bank reports that China was only 53% urbanized as of 2014. To get to 75%, 250 million more Chinese would have to move to the cities. Meanwhile, India is only 32% urbanized. To reach 75% urbanization, more than half a billion people would have to migrate to urban centers.

Now, that doesn’t mean China and India will hit these numbers tomorrow. But they’ll probably move steadily in that direction, which should provide plenty of upward pressure on commodity demand.

And there are plenty of other countries beyond China and India that are urbanizing. Countries like Vietnam, Cambodia and the Philippines would be obvious examples. But many African countries are rapidly urbanizing as well.

In fact, there’s quite a lot more going on in Africa these days. A new common market – the Tripartite Free Trade Area – is starting up in Africa. It will span half the continent, creating a market with a population of 625 million people and gross domestic product of more than $1 trillion.

Again, this should be a force for urbanization and commodity consumption.

Force No. 3: China’s Petroyuan

China defined the commodities market for more than a decade as it gobbled up raw materials of all kinds to feed its tremendous growth. Now, the pace of China’s growth is slowing, and this slowdown has weighed on commodity prices.

But let me show you why this is a short-term dip rather than a change in the big trend. China already plays host to some of the world’s most heavily traded commodities futures.

Shanghai, for example, operates the world’s largest physical gold exchange. But that’s not all. Chinese exchanges also move large and growing volumes of soy meal, coal, sugar, rubber, palm oil, iron ore and copper.

And now, China will be launching its own crude oil trading. The Shanghai Futures Exchange says it will start trading the new oil contracts this year. And it will be the first Chinese commodities market fully open for trading to foreign investors.

Importantly, China’s new product won’t be priced in dollars. Contracts will be denominated in China’s currency, the yuan, or renminbi. I’ve told you how China wants to launch the petroyuan and knock the U.S. dollar off its high perch; this is one more piece of that puzzle.

Also, the Shanghai futures will be based on 100 barrels of oil. That’s smaller than most other globally traded oil futures, which are based on 1,000 barrels. Finally, Shanghai oil futures will be keyed to the price of China’s imports of medium-sour crude oil.

China’s markets for oil, gasoline and other commodities are moving down the path toward deregulation. This is likely going to stir up even more demand for commodities.

So there you have it; I’ve highlighted three major trends that are likely to spark and sustain a new bull market in commodities. But those aren’t the only commodity-friendly trends in development. Here are a few more:

• The U.S. dollar is probably topping – which is not helped by the fact that President Obama told a meeting of the G7 Industrialized Nations that the strong dollar was “a problem.”
• Sentiment on commodities is extremely bearish after years of underperformance.
• New supplies of most commodities are in decline. That’s because it’s easier to get financing for a nonsensical Internet app company than for a project that produces any sort of essential industrial commodity.

These reasons and more point to commodities being much closer to a bottom than a top.

There are plenty of ways to play a budding commodity boom. One of the easier ones is the PowerShares DB Commodity Index Tracking Fund (NYSE: DBC). Price is $17.91. It tracks a basket of commodities (like the CRB Index) and is plenty liquid enough to be tradeable. But as always, please be sure to do your own due diligence before you buy anything.

All the best,

Sean Brodrick