A Case For Rising Prices In Commodities…Including Gold And Silver

Historically the “invisible hand”, which was always at work in the global investment market, intuitively knew how to “read and play the markets”.  However, it is increasingly difficult for the invisible hand to “read” the markets since the signals are increasingly distorted, due to a number of factors including the following:

  • Global sovereign debt is at record levels, so the “interest suppression” interests of Government are at odds with the interests of savers/business;
  • Interest rates, which were the risk barometer for investors, are being held artificially low to encourage continued consumption, which disables the market’s mechanism to communicate risk to investors with rising bond rates;
  • Inflation rates are manipulated to the downside to make GDP growth (and politicians) look better, so no-one actually knows how the economy is doing;
  • High frequency and computerised early eastern time trading has allowed market price manipulation;
  • The expanding bias in favour of negative interest rates, has precipitated a search for yield (read risk) that “shifted” investment and is driving the pension industry to actuarial insolvency and causing investors to take imprudent risks;
  • Deficit spending, which has favoured consumption and big business will, almost certainly peak and end in Austerity and Balanced Budgets in the next few years – at most a decade?;
  • Increasing Government intervention and legislation at both the domestic and international levels, make it increasingly difficult for business to operate and, at the very least, add to the cost of doing business;
  • The “War against cash”, starting with “big notes”, comes at a time when investors are favouring holding physical cash rather than losing money to negative rates at the bank;
  • The bias in favour of shorter term vs. longer term investment horizons makes the really big investments, particularly in infrastructure services, difficult to motivate;
  • Uncertainty created by the transition from a more parochial “industrial era” model to a more homogenised global market “exponential technology era”.  Bearing in mind that all transition is by its very nature disruptive, it is useful to note that there is not a single industry or aspect of business that is not being affected by disruptive technologies.

Due to some or all of these dislocating uncertainties, the traditional investment paradigm is almost certainly being turned on its head – albeit only for a decade or two.  Consequently, I believe we are at the start of an era that is favouring diversification into investments which guarantee a “return OF your investment” over those associated with the former preoccupation with an ever bigger “return ON your investment”.  This is making it increasingly difficult for investors to know where to invest and is bringing some less conventional investments such as rarities, antiquities, art, Gold and Silver back into the spotlight.  For greater perspective, I present these three slides produced by South African economist Chris Hart.   However, I think the situation is now direr than that suggested by Chris a few years ago, so I have added a 4th stage, which I explain further down.

These were the three brilliant slides presented by Chris Hart – RSA Economist

Normal investment environment – normal strategies below

Governments printing money in excess to the point of no return “A-la-Zim” = higher interest rates & inflation with time

Reasons why inflation has not yet manifested are explained in my article http://www.gold-eagle.com/article/poverty-and-unemployment-are-here-stay

Fiat money turns the traditional risk/reward paradigm on its head – Reasons:

  • Prospect that Fiat money will result in cash becoming worthless A-la-Zim; and the
  • Prospect that the inevitable rise in rates will cause bonds to fall or collapse.
  • Therefore, equities become one of the least ugly sisters.  In a Fiat environment, Equities could do well, despite the fact that equities do not usually perform well during periods of rising rates (explained further down).  I am of the opinion that one should invest mainly in new technology equities, commodity equities and discount stores that sell “basic need products” like food and clothing.  Definitely all equities should be biased in favour of those paying dividends (value investing). 

However, I think we have reached another level and add another dimension

So here we are in an environment where there is considerable uncertainty about the direction of interest rates and clever investors are probably saying something along the following lines:

  • I am going to better “hedge my bets” and reduce my exposure to the more traditional asset classes for the following reasons:
    • Equities are currently pricey when valued using CAPE and margin debt is at levels that usually precede crashes or big corrections. While they could go either way, there is less upside potential and considerable downside potential;
    • There’s a risk that rates will increase, which is bad for Equities because in the longer term there is a strong inverse correlation between equities and rates – i.e. when rates increase, equities decline and, as we saw in the past 35 years, when rates decline, equities rise (if you do not understand this there is an explanation at the end of this article).
    • Rates cannot go much lower, even if they go negative, therefore there is little upside potential for Bonds and it is becoming risky to hang in there for it.  Essentially it is only a matter of time before rates rise and the Bond market collapses (it’s 2.5 times the size of the Equity market);
    • Cash is yielding negative returns and banks can go bankrupt;

In essence, it is a time to reduce third party risk and, if this is true, how can Investors hedge while still remaining diversified, especially in a time when global diversification is being discouraged with legislation and bureaucracy. 

I think, investors are increasingly looking at this additional “Tangibles” level, as they have driven prices of rarities and antiquities to record levels and are starting to look at Gold and Silver.  I also think they may be looking at Commodities as these are also tangibles and seem to have bottomed. See my case for commodities below.

I THINK!!!  Commodities are a good “long term bet” for the following reason.  Below I have created a table that indexes the probable increase in demand for commodities driven by two things, namely growing global middle class who are starting to consume more and growing global population that will also consume more.  You will see that in both cases, the demand for food and commodities is set to double.  The only caveat is that technology advances may to some extent improve production efficiencies and reduce waste.

NB! The assumption is that the middle class in countries like China (1.25bn), India (1.25bn), Malaysia, Indonesia, Thailand, etc (0.5bn+) have over 3 Billion people, all of which economies are growing rapidly.  Africa, much of S America etc. = the REST.

There is no “absolute truth” in all of this, only probability and food for thought.

Best regards

Eelco Lodewijks – see links and appendix below

Understanding tangibles – see earlier articles



Explanation: Inverse relationship of Equity vs Rates (skip if you know this)

In the longer-term, the price of equities is “inversely” linked to risk free interest rates, which are represented by 10 year Government Bonds.  The reason for this is that “historically” one could get a risk free return on one’s money from a Government bond – based on the assumption that a Government could not go bankrupt.  However, this risk free rate did not typically provide a significant “real return on investment” after allowing for the effects of inflation.  In order to properly beat inflation and earn a higher “real return in investment” investors look to alternative “more risky” investments in other markets.  However, the minute investors start to look at more risky investments, they want to be rewarded for taking on extra risk and, therefore, price a “risk premium” into the price of those investments.  In the case of equities, the “risk premium” over the risk free rate can usually be quantified quite accurately.  In essence, it works as follows:

  • The earnings of an investment as a percentage of the price of the investment should be higher than the risk free rate PLUS an acceptable risk premium. Eg. Let us say the Risk free rate is 2% and the risk premium is 2%.  Therefore the 4+% desired earnings of the investment is divided into the earnings per share to determine the price.  When the risk free rate rises, the denominator becomes greater and consequently the investment’s price falls and vice versa.


Eelco Lodewijks (South Africa)

Eelco Robert Lodewijks was born in South Africa.  He has  a BSc Civil Engineering from University of Cape Town and a MBA from UCT.   Mr.  Lodewijks lectures Advanced Excel and Advanced Financial Modelling in Excel on the international circuit (including Hong Kong, Singapore, Brunei, Malaysia, Dubai, Kuwait, RSA, Mauritius, Zambia, Nigeria, Uganda, Tanzania and Zimbabwe).   His early career was spent in construction site management on large multi-million Dollar projects, both in South Africa and the Middle East, where-after he did his MBA. 

In 1934 President Franklin Delano Roosevelt devalued the dollar by raising the price of gold to $35 per ounce.