If I could summarize any commodity-based business or cycle in one long-term chart, this is it.
The trade weighted US Dollar, show below:
This is the most important chart to watch over the next decade. The red dotted lines are decade-long periods where the US Dollar depreciates against other world currencies, and the green dotted lines are decade-long periods where the US Dollar appreciates against other world currencies.
Reserve Currency
The US Dollar is important globally because it's the reserve currency for the rest of the world. It therefore acts like the central bank for the rest of the world: monetary conditions tighten when the US Dollar is appreciating, and monetary conditions loosen when the US Dollar is depreciating. Growth for most of the developing world does materially better when the US Dollar is depreciating and does typically worse when the US Dollar is appreciating. You can think of it as a tailwind or headwind for economic growth; above trend growth when it's going down and below trend growth when its going up.
Impact on Commodities
Most commodities are traded in US Dollars. When the US Dollar is getting cheaper relative to a foreign buyer, they're able to buy more commodities, this causes the demand for commodities to increase. So as the US Dollar depreciates, economic growth is stimulated and demand for commodities gets magnified. Further, as the US Dollar depreciates it enhances the competitiveness of US exports - of which commodities play an important role - crude oil, coal, natural gas, etc.
If you look again at the chart, you can think back to periods of good times for most extractive commodity-based industries. These good times generally align with the red dotted lines and US Dollar depreciation, whereas the difficult times for the resource sectors generally align with the green dotted lines and periods of US Dollar appreciation.
I think we've turned the corner and we're in for a decade-long period of US Dollar depreciation which should last throughout the 2020's.
US Exceptionalism
These US Dollar cycles typically coincide with the waxing and waning of US exceptionalism. During periods of increasing US exceptionalism, US financial markets are well respected and US CEO’s and tech companies tend to take center stage. US markets are flush with capital in these periods and US tech stocks or other large caps tend to be the most valuable companies in the world. Think back to Jack Welch at GE and the internet stocks of the late 1990’s or Elon Musk at Tesla and Jeff Bezos at Amazon in today’s markets.
During decreasing US exceptionalism emerging markets tend to take center stage for financial growth as capital flows away from US markets and into emerging markets. During these periods, commodity-based companies become the most valuable companies in the world since they’re doing their part uplifting living standards for vast swaths of global population and adding value to people’s lives. At the bottom of the last red dotted line, in 2007/8, the most valuable public company in the world was Exxon Mobile. If you recall back to that period, China took center stage in the financial world as the cycle basically culminated with the Beijing Olympics.
Moving Forward
The pendulum swings hard in each direction and I think it's about to turn back towards valuing raw materials needed for everyday life as more important than imagined trips to Mars. This also means US exceptionalism has peaked for this cycle. The rest of the world can see the bailouts and stimulus programs and the rise of corporatism for what they are, simply transfers of wealth to the rich while propping up the poor with handout money. With each bailout of the financial system the US markets become less competitive, and with each round of stimulus and quantitative easing, the incremental effect on growth becomes weaker and weaker. The nominal effects make US consumers and investors feel better, but the detrimental impact of future inflation is likely to make wealth inequality even worse in the US.
It makes sense for capital to go elsewhere and seek geographic areas of real growth. To find markets where populations are growing and living standards are increasing. This will result in less demand for US Dollars which pushes it lower, and the flywheel effect of the world’s reserve currency depreciating, which is stimulative for EM growth will cause the trend to continue far longer than most believe possible.
These decade long cycles tend to continue until something big smacks the status quo in the face. Then and only then do they reverse. In 2001/2 it was 911, in 2007/8 it was the Great Financial Crisis, and the catalyst for reversal of the current cycle is obviously Covid.
Commodity Super Cycle
By now I’m sure you realize that the commodity super cycle is really just the US Dollar cycle. These decade long cycles don’t turn on a dime, they take a while to show their hand with many fits and starts to shake out the early entrants and the weak willed. Make no mistake however, the commodity super cycle is turning up while the US Dollar has begun to turn down. In order to navigate our way through this we will try to lean into emerging market equities, commodity producing equities and commodities themselves.
The broad based emerging market ETF’s are flawed, they’re mostly filled with SE Asian tech companies. What we need could be classified as “value” these days, but it’s really just natural resource companies with real assets and international exposure. I have a lot of ideas about which companies will be the most valuable at the top of the cycle we’re entering, and I will touch on all of them eventually in future articles…
So Welcome & Stay Tuned!
This is the first article of The Coal Trader newsletter and I haven’t mentioned the coal sector yet. The research and articles that will follow will touch on all aspects of the various natural resources sectors, and although there will be a lot of macro, top down analysis, I plan to do my fair share of digging in the weeds to find value and alpha for your own investment portfolio.
I’m personally looking forward to the journey.
I just started following your work on Twitter and here. Big new fan. Thank you for your sincerely helpful insights.