What the Next Decade Holds for Commodities

By Frank Holmes, CEO and Chief Invest­ment Offi­cer

U.S. Global Investors

What a decade! A rapidly urban­iz­ing global pop­u­la­tion dri­ven by tremen­dous growth in emerg­ing mar­kets has sent com­modi­ties on quite a run over the past 10 years. If you annu­al­ize the returns since 2002, you find that all 14 com­modi­ties are in pos­i­tive territory.

A pre­cious metal was the best per­former but it’s prob­a­bly not the one you were think­ing of. With an impres­sive 20 per­cent annu­al­ized return, sil­ver is king of the com­mod­ity space over the past decade with gold (19 per­cent annu­al­ized) and cop­per (18 per­cent annu­al­ized) fol­low­ing closely behind.

Notably, all com­modi­ties except nat­ural gas out­per­formed the S&P 500 Index 10-year annu­al­ized return of 2.92 percent.

Last year did not seem reflec­tive of the decade-long clamor for com­modi­ties. In 2011, only four com­modi­ties we track increased: gold (10 per­cent), oil (8 per­cent), coal (nearly 6 per­cent), and corn (nearly 3 per­cent). The remain­ing listed on our pop­u­lar Peri­odic Table of Com­mod­ity Returns fell, with losses rang­ing from nearly 10 per­cent for sil­ver to 32 per­cent for nat­ural gas.

Down­load a pdf of the com­mod­ity table here

I think this chart is a “must-have” for investors and advi­sors because you can visu­ally see how com­modi­ties have fluc­tu­ated from year to year. Take nat­ural gas, for exam­ple, which posted out­stand­ing increases in 2002 and 2005, but has been a cellar-dweller for the last four years as a result of over­abun­dant sup­ply and soft­en­ing demand. The indus­try is also still try­ing to digest break­through tech­nol­ogy that opened the door to vast shale deposits at a much lower cost.

On the other hand, oil fin­ished in the top half of the com­mod­ity bas­ket six out of the past 10 years. No stranger to volatile price swings, oil pos­sesses much more attrac­tive fun­da­men­tals as we con­tin­u­ally see restricted sup­ply cou­pled with ris­ing demand.

After 11 con­sec­u­tive years of gains, some are ques­tion­ing whether gold can keep its win­ning streak alive in 2012. One of those skep­tics is CNBC’s “Street Signs” co-host Brian Sul­li­van. In an appear­ance on Thurs­day, I explained how I believe the Fear Trade and Love Trade will con­tinue to for­tify gold prices at his­tor­i­cally high levels.

I explained that one of the rea­sons the Fear Trade will per­sist in pur­chas­ing gold is the ever-rising gov­ern­ment debt across numer­ous devel­oped coun­tries. Dur­ing our Out­look 2012 web­cast, John Mauldin kid­ded that the Mayans were not astrologers pre­dict­ing the end of the world, but econ­o­mists pre­dict­ing the end of Europe. Whereas John believes the U.S. has wig­gle room to decide on how to deal with deficits and debt, Europe and Japan are run­ning out of time.

The sit­u­a­tion is quite somber when you con­sider how much debt Europe, Japan and the U.S. owes this year alone, says global macro research provider Greg Wel­don. In his pre­view of 2012, Wel­don says that the matur­ing prin­ci­pal and inter­est on U.S. Trea­sury debt due this year totals just under $3 tril­lion. Aus­tria, Bel­gium, France, Ger­many, Italy, Por­tu­gal and Spain together face nearly $2 tril­lion in prin­ci­pal and inter­est pay­ments. Japan is the leader in the club­house, owing just over $3 tril­lion in 2012. With the com­bined debt for these devel­oped coun­tries total­ing nearly $8 tril­lion, the inter­est pay­ments alone dwarf the total GDP of many coun­tries in the world.

This week, Ger­many sold a five-year gov­ern­ment note for less than 1 per­cent, the low­est inter­est rate on record. Bids for the low-yielding debt were three times more than the amount sold, even as the con­sumer price index stands at more than 2 per­cent year-over-year. This means that investors have so few accept­able safe havens they are will­ing to accept neg­a­tive real rates of return.

This is good news for gold as a safe haven alter­na­tive against depre­ci­at­ing cur­ren­cies such as the euro, the yen and the U.S. dollar.

The over­whelm­ing debt bur­den in devel­oped coun­tries trans­lates to an expected slow­down in imports from the emerg­ing world. How­ever, the grand­est of those coun­tries, China, likely won’t be affected as much as some peo­ple assume. This is “the biggest mis­con­cep­tion” about the country’s econ­omy, says CLSA’s Andy Roth­man. Exports only play a sup­port­ing role for the Chi­nese econ­omy. The world’s second-largest econ­omy is actu­ally largely dri­ven by domes­tic con­sump­tion from a pop­u­la­tion more than 1 bil­lion strong with more padding in their wallets.

Andy says 10 years of tremen­dous income growth and lit­tle house­hold debt, make China the “world’s best con­sump­tion story, for every­thing from instant noo­dles to lux­ury cars” in 2012.

Accord­ing to Decem­ber Chi­nese trade fig­ures, month-over-month and year-over-year imports of alu­minum and cop­per increased sig­nif­i­cantly. This may be a result of China restock­ing ahead of Chi­nese New Year, but M2 money sup­ply growth rapidly rose in recent months, a sign the gov­ern­ment is attempt­ing to reac­cel­er­ate the econ­omy. Also, the urban labor mar­ket has been robust over the past two years, with an annual change just below 5 percent—a record high over the past 15 years.

Along with ris­ing urban employ­ment, income growth has been tremen­dous as well. CLSA says that last year was “the eleventh con­sec­u­tive year of 7 percent-plus real urban income growth,” with dis­pos­able incomes ris­ing 152 per­cent over the past decade.

Investors shouldn’t expect China’s growth to be as robust as it’s been, as the country’s fixed asset invest­ment growth drops below the 25 per­cent year-over-year pace of the last nine years, says CLSA. China’s 12th Five-Year Plan has less infra­struc­ture spend­ing com­pared to the 11th five-year plan. Trans­port and rail spend­ing is also expected to drop, with only water and envi­ron­men­tal pro­tec­tion spend­ing growth rising.

As shown in the BCA chart above, GDP growth has declined below 10 per­cent, but the growth is cur­rently not the low­est we’ve seen in recent years. CLSA believes that China will pre­vent GDP growth from slip­ping below 8.5 per­cent for the full year, as “Bei­jing has the fis­cal resources and polit­i­cal will to quickly imple­ment a much larger stimulus.”

Judg­ing by the record num­ber of arti­cles men­tion­ing a hard land­ing in China in late 2011, investor sen­ti­ment has swung from eupho­ria to exces­sive pes­simism, accord­ing to BCA Research. Last fall, more than 1,000 arti­cles dis­cussed the risk of a “China Crash.”

As I’ve men­tioned before, con­trar­i­ans view extremely bear­ish sen­ti­ment as a poten­tial attrac­tive entry point. BCA believes the pes­simism has been priced in, as tech­ni­cal indi­ca­tors as well as val­u­a­tions for domes­tic and investable mar­kets appear “deeply depressed.”

What will hap­pen over the next 10 years? I believe the super­cy­cle of growth across emerg­ing mar­kets will con­tinue with ris­ing urban­iza­tion and income rates. This bodes well for com­modi­ties, espe­cially cop­per, coal, oil and gold, and we’ll con­tinue to focus on com­pa­nies that will ben­e­fit the most from these much-needed resources.

Frank Holmes is CEO and chief investment officer of U.S. Global Investors, Inc., and a Toronto, Canada native, which manages a diversified family of mutual funds and hedge funds specializing in natural resources, emerging markets and infrastructure. The company’s funds have earned more than two dozen Lipper Fund Awards and certificates since 2000. The Global Resources Fund (PSPFX) was Lipper’s top-performing global natural resources fund in 2010. In 2009, the World Precious Minerals Fund (UNWPX) was Lipper’s top-performing gold fund, the second time in four years for that achievement. In addition, both funds received 2007 and 2008 Lipper Fund Awards as the best overall funds in their respective categories. Mr. Holmes was 2006 mining fund manager of the year for Mining Journal, a leading publication for the global resources industry, and he is co-author of “The Goldwatcher: Demystifying Gold Investing.” He is also an advisor to the International Crisis Group, which works to resolve global conflict, and the William J. Clinton Foundation on sustainable development in nations with resource-based economies. Mr. Holmes is a much-sought-after conference speaker and a regular commentator on financial television. He has been profiled by Fortune, Barron’s, The Financial Times and other publications. Read more from the author/contributor here.

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