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Commodities Outlook for 2006

Clyde Harrison
February 18th, 2006

At Energyeditor.ca, every six months we try to talk with Clyde Harrison, manager of the Brookshire Raw Materials Fund, and co-founder of the Rogers Raw Materials Fund. Always quick with a quip, he gives a seasoned and reasoned insight into commodity markets. We went fishing for his outlook on 2006, and he took the bait. Our interview took place over two days - one on February 7, a correction day for all commodities, and one a week earlier.

EnergyEditor: OK Clyde, what do you expect in the various commodity prices this year - and in the US dollar, which is key to any commodity price.

Clyde Harrison: Well, I think a lot of things are going to go sideways this year. I predict China will have a slight recession. There are too many what I call "see through buildings". The numbers I see out of China are terrible - more than 200,000 condos have been built but have no electricty turned on. I caution that there are very few things in China can you truly track, but I think it's over built right now, which is bad for real estate there.

I would buy natural gas right now. We have only had one snow storm come through, but my guess is the reason you have "normal" temperatures is that that's where temperatures end up. It has been warm for a month, now it could get cold for a month. Do you know a good weatherman? I don't know any I would give money to.

Oil is politically priced, making it very difficult to trade. Iran is a nutcase. Do you want to trade on a nutcase? I think at US$55-57 a barrel you close your eyes & own oil. Everything over that you better be very cautious. But you would be foolish to short it - it could go up another $10.

I'm neutral on gold. I think there is an economic softening around the world. Asian markets are overloved by non-Asians. In a softer economy the Asians won 't be buying gold - they don't have the money. Their money is part of what has run this gold market.

The biggest influx in the Japanese market is US money, which is a bad sign. You want the guys internally, in their own country, to love it. But we're printing baskets of money, and it has to go somewhere. Japanese investors aren't believing their market at this price. This is all Economics 101 in the final analysis.

2006 will be another down year in US stocks. There will be flat or zero growth in the US this year. The dollar has peaked again, in my opinion. It will be a slow bear market. In four or five years the dollar will go into freefall, likely after the Chinese Olympics. If they put consumer credit system, they will become their own customer & then they'll tell the US we don't need you. - China needs the US buying public as customers. They have taken down so much US currency and are spending it around the world. They would rather have the US currency drop 4% a year than have 25 million 25-year-olds out of work. But when they have their own demand market, look out.

EnergyEditor: Is there any precedent for the run in commodity prices we have seen in the last three years?

Clyde Harrison: For base metals, no. But back in the 1970s, soybeans went from $3 to the teens without hardly a hiccup. Listen, if I'm building a $30,000 car and there are only 650 pounds of copper in it, and copper goes to $2, I don't care. It's not a big price influencer. Look at CornFlakes. All the money for the cereal box you buy goes for the advertising. Corn is probably only 40 cents of a $4 box. Tony Tiger is the expensive part.

EnergyEditor: What are the stages of a commodities bull market, and where are we now?

Clyde Harrison: People still don't believe it yet, but this is not a one or two or three year cycle. There are three periods in markets like this. The first period is about the companies that were in it during the lean years; the survivors. They were operating when commodity prices didn't move, but costs did. So they rationalized, downsized, and now those companies are making tons of money. In period two, money is poured into infrastructure - trucks, mines, etc - while commodity prices still on the way up. The comes period three, when then all this comes online. Now you've spent the money. And supply rules now, not demand, and this is the top.

But we have 10 -15 years of fun here ahead of us. Look at drive-in restaurants in China. We are just beginning phase two. There are 280 people per car in China, vs 2 in Europe, but that is still a lot of people. A huge thing is coming. This bull market in commodities would have happened anyway, even without China. It's called supply constraints. In 1980 in current money oil hit $80 and America had some 5000 operating oil wells. Then when oil hit $15 years later, America had only about 800 wells. So many wells had been shut down, whether it was the EIA or low oil & gas prices. But this will be the biggest bull market commodity cycle because the third world has found capitalism - I'm a raging bull and I probably won't believe the prices. For example, when Japan started to commercialize, that culture didn't drink coffee. Now they consume about 90% of what America does. In Brazil they were cutting down coffee trees to plant soybeans., that's what a bottom looks like. Putting a copper mine in Barbra Streisand's backyard, that's what a top looks like.

EnergyEditor: Seriously, how will we recognize a top in this cycle?

Clyde Harrison: Back at end of last "stuff" cycle in the late 1970s, people were complaining on the bus ride home about oil & energy prices. Whenever you came home somebody in your neighbourhood had an insulation truck in front of their house putting more insulation in. People were trading in Cadillacs for more fuel efficient cars. Well, I live on the water, and I still see lots of twin engine fast boats going by my house as I ever have . Another sign of the top is when people get so mad that Congress will act to allow for a lot more exploration in the US. And we're not seeing that yet. In the early 1980s oil companies were 28% of the S&P, then they bottomed at 4%, and they're now at 8%, so we still have a long way to go. By the time we get to the far end of this cycle, everybody will have this asset class in their portfolio, but only 3% of people do today. But remember, it's the Chinese who are driving energy prices, and their choices are hugely different than ours. We talk about falling SUV sales or something, but millions of them are trading in bicycles for motorbikes.

EnergyEditor: Clyde, it is always a pleasure speaking with you. Thanks for your time.

 

Clyde Harrison
February 18th, 2006