Worldwide commodity is a US $ 7 trillion market. Based on 2006 data, crude oil[41%] is the biggest stuff that we consume and followed by agriculture[31%]. Crude oil naturally will occupy the lion share in DJ-AIG Commodity Index. The index cannot move significantly higher unless crude oil begin to move.
Agriculture is the next biggest commodity that we consume. The writing has been on the wall that the soft commodity inventory have been declining for a long time. I did not want to cheer along when the price was high at that time, now that the price has collapsed and the "fact" remains unchanged. Now it's a more appropriate time to write about them though not many people will want to read them. A lot of countries going after the same high tech industries for last 30 years and neglecting agriculture sector. The cycle time to increase supply is not that long in terms of planting to harvesting but to convince more people to give up a job with nice Gucci tie to be a farmer will be an uphill battle. The sacrifice is just too huge, so we need a lot of incentives ( primarily higher price) to convert them.
I have written before the key demand drivers in soft commodities primarily due to higher standard of living and the dumb idea of diverting food to bio-fuel. Consider this:
China’s role has been profound, reflecting its enormous economic progress and huge population. In the past decade, says Carlo Caiani of Caiani & Company, an investment-advisory firm based in Melbourne, the consumption of milk has grown seven-fold, and that of olive oil six-fold. China is consuming twice as much vegetable oil (instead of less healthy pork fat), 60% more poultry, 30% more beef and 25% more wheat, and these are merely the obvious foods. Scores of niches have expanded dramatically: people are drinking four times as much wine, for example.
And yet even with all this growth, people in China still, on average, consume only one-third as much milk and meat as people in wealthy countries such as Australia, America and Britain. The gap is even larger with India, which is also growing fast. Overall, protein intake in Europe and America is unlikely to expand much, but a combination of rising incomes and population in developing countries could increase demand by more than 5% annually for years to come. “Once people are accustomed to eating more protein, they won’t take it out of their diet,” says Mr Caiani.
Expanding supply at the same rate will be difficult, because the amount of arable land under cultivation is growing by only a fraction of a percentage point each year. In China and India many of the most fertile areas are the ones being developed for roads and factories. That means existing land is becoming more valuable, and must become more productive.
The Economist: Green Shoots
The second driver was sacrificing food for fuel. We can relax a bit due to weak demand for crude oil. But when crude oil demand is back, it will come back with a vengeance.
Most of the older arguments are still valid except weaker crude oil demand is taking some pressures off. But there is a new argument getting stronger because of the FED and possibly ECB doing QE will trigger high inflation. When the investment pros acting on the argument, the pursue of hard assets will quickly push up commodity prices. Consider this chart on the correlation between commodity and inflation.
To sum up thing: the perfect storm will happen when fundamentals, inflation and weak US $ collide. There is also a possibility of commodity price going higher in tandem with equities.
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