Is the Commodity Boom Over? Or Did It Never Happen in the First Place?
Today, I’m going to have an argument with myself. Which might not seem helpful at first. But busting flimsy narratives is the first step of any epiphany.
There are two competing narratives when it comes to commodities. And don’t forget, commodities are incredibly important to explaining Australia’s prosperity. But which of the two narratives is correct? Is the commodity boom over, or did it never happen in the first place?
As a warmup, so you can get a flavour for what I’m going to claim, consider the gas boom.
Building the infrastructure required to produce and export gas is labour and capital intensive. But pumping and selling the stuff, once you’re fully set up, is less so. Once the gas flows, it’s just the market price and cost of production that matters to the equation.
So when does a boom actually happen in this story? If huge gas reserves are discovered, like in Australia, is the boom in preparing for gas production or actually producing and selling it?
It’s a little odd to think that the set up expenses are the real economic boom, right? Surely it’s the revenue from all that gas which matters? The payoff is the prosperity. But I’m not sure that’s true. Not for the economy and especially not for investors.
In terms of jobs, GDP, investment gains, and plenty of other measures, it’s all about what happens around the gas itself which creates prosperity. Of course you still need the gas to pay off in the end. But that’s not where the wider impact lies for the country.
I’d like to bring this same thinking to commodities and Australia more broadly. My point is that we’ve had a bizarre experience in Australia over the last decade.
The two competing narratives I want to dig into seem contradictory. But if you divide the boom up in the way I describe above, things start to make sense.
The first narrative says that a boom in commodities made Australia the most prosperous place on Earth. Prosperous as defined by mine and my parents’ multiyear quest to find the best place in the world to live.
The nicest homes in the nicest places with the nicest lifestyles, and the lowest chance of destitution. I regularly read Aussie news headlines when commuting to the office here in London, to highlight just how serene life is in the land of Oz.
Commodities even dragged Australia back from the 2008 recession cliff via Chinese stimulus. The commodity boom created a jobs boom where cleaners and college dropouts could earn six figures working one week on, one week off.
And yet, that narrative is sort of iffy if you look at the commodity price data. Commodity prices haven’t actually performed so well. Especially relatively speaking. That’s the opposing narrative.
This chart shows that commodity prices plunged relative to stocks since 2008. In other words, financial assets outperformed commodities.
Now, Australia has plenty of financial assets too. But how can commodities fall to the lowest level in many decades during an Aussie commodity boom? Where does the commodity boom narrative come from given the price data is so disappointing?
The answer lies in the nature of the boom. It was a capex boom — spending to get all that commodity production up and running. The problem is, it didn’t pay off as well as expected in the end because during that boom, prices kept underperforming.
No doubt you’ve heard about what happens in gas boom towns when the capex spike ends. All those tradies who flooded remote towns and bid up property prices suddenly disappear.
Is that about to happen to Australia’s economy as a whole? Is the commodity boom’s economic boom over and the age of cash flow with minimal economic activity about to begin?
Should you change your investment mix?
If so, then it could be important to change your investment mix. You might want to sell companies that benefit from economic expansion in Australia more broadly. But what do you buy instead?
I think the answer lies in the second half of every commodity boom. When the revenues start flowing in as the commodities flow out.
If the equation of operating costs and commodity prices is what matters in the latter part of a boom, rising commodity prices would make things very interesting for investors. Think of it as a surge in margins after a decade-long crunch. That’s what matters to mature businesses, not growth ones.
But is such a rise likely? Well, the chart above shows that the ratio is at extraordinary lows. Which usually means an upturn is in sight — rising commodity prices relative to financial asset prices. This is a dream scenario for commodity producers.
My point is that Australia and its commodity economy is about to enter the age of the rentier. Where what you own pays you money without really doing much good in terms of GDP, jobs or labour. At least, not in terms of growth.
That’s good news for those with capital and on the lookout for income. It’s bad news for low-skilled workers looking for a job in the mines.
Australian investors will do well out of phase two of the commodity boom. Australia will not. This is precisely the reverse of the last 10 years when the economy did well, but falling commodity prices undermined investment returns in commodity stocks.
Nuance so often resolves arguments…
Until next time,