Asset prices move in waves. Ever since the great depression of the 1930s, the equity markets have risen in bullish waves that tend to last 7 to 9 years then selloff in a sharp fall that usually erases 1/3 to 2/3ds of the previous gains. Those sell-offs tend to last 1 or 2 years. The bond market undergoes waves that last much longer. The current bond market rally started in 1981 and probably ended last year. Unlike the stock market, the rise and fall in interest rates are more symmetrical. The great bond bear market started sometime in the 1940s after the great depression ended. It lasted for 35 to 40 years. By the end of that phase, market commentators called bonds “certificates of confiscation” as the rising rates caused bond prices to fall. To add insult to injury, inflation plus income taxes assured the owner lost purchasing power, even though they may be collecting a yield of 10% or more. This is the perfect psychology for a change in directions.
Now that bond prices are falling and interest rates are rising, history tells us that we might expect this process to go on for a number of decades. After the financial crisis, bonds yielded crashed. Central bank buying drove prices up and yields down. At the same time, many investors were shaken by the 60% drop in equity prices and equally huge drop in the price of real estate. Now that bonds yield just a few percentage points bond investors, like pension funds, have seen their purchasing power erode and the funding levels of their plans collapse. With experience in our minds, we expect investors to continue to demand higher rates. Without higher rates, holding bonds continues to be a losing proposition. In the corporate world, this will lead to a continued wealth transfer from bondholders to stockholders.
Higher bond yields are usually associated with higher inflation. A fair rate of return gives the bondholder a real rate of return after taxes as compensation for credit and interest rate risk. Higher inflation rates are also associated with rising commodities prices. Commodities rise in price because it costs more to produce them when the price of labor and business goods and services rise in price.
With equity prices approaching the blow-off phase of their bull run, we should expect a new bull market in commodities or at least one might expect that commodities will outperform equities for a number of years.
The chart above shows that there seems to be a cycle in the relationship between the price of equities and the price of commodities. In the chart above, peaks in this relationship seem to come along every 20 years or so. Further, bottoms in the relationship come when the price of commodities/price of equities is less than 1. This is where the market finds itself now. If indeed the price of commodities is about to rise, we think that rise will be across the board. We should see the price of food, minerals, lumber, oil, cotton, etc. Begin to rise. At first, it will be one group like the minerals, then as they stabilize at higher prices the agricultural commodities will take the lead, then they will stabilize at higher prices and the soft commodities will take the lead. It will not be until the inflation in the commodities hits the center of their rally will we see all or almost all of them rise at the same time.
Our readers know that charts give us the first clue to price trend or the potential for a change in direction like the one shown above. But we also like to consider valuation and sentiment as well. Valuation is very tough with commodities. They do not generate cash flow and they do not pay dividends, so you cannot use traditional valuation measures like you can with stock.
All you can do is look at the cost of production. If the price of a commodity is below the cost of production, it is just a matter of time before the supply overhang wears off and prices begin to move to a level that provides a return on capital for those who produce the commodity. At this point, the big mining companies are operating at a loss or a breakeven at best. (We cannot find industry data for 2017, but since the price of metals did not change much in 2017 from 2016, we can safely estimate that profit margins have not improved.)
Farmers income is doing better than mining income, but their profits are down substantially from a few years ago. Net farm income is down 50%. This tells us that there is probably more pressure on the price of metals than the price of food.
Investors sentiment is something we can look and we have found an anecdotal piece of evidence that investors are giving up on commodities. Reuters reports that a big, British blue chip commodity hedge fund is closing down. What we find interesting is the reason why. If you read between the line, we think the macro players who were bullish commodities as an inflation play due to Quantitative Easing are not getting the price action they expected. After many years of stagnating commodity prices, these folks are giving up on the sector. Capitulation may be at hand, which puts in the foundation for a tradable rally of some importance.
NEW YORK/LONDON (Reuters) – Jamison Capital Partners LP, a New York-based macro commodity hedge fund run by former Morgan Stanley trader Stephen Jamison, will shut its nearly $1.5 billion fund by the end of the month, according to a source familiar and an investor letter.
The firm is shutting its Koppenberg Macro Commodity Fund by Jan. 31, according to the letter reviewed by Reuters. The firm will convert into a family office, the source said. “Commodity trading is tough, with no coupons, dividends, or real price appreciation over time to soften the blows. It’s becoming even tougher,” Stephen Jamison said in a Jan. 24 letter to investors.
The closure of Jamison, one of the largest commodity-focused hedge funds, comes after several other big names have closed shop in recent months. They include hedge fund manager Andy Hall, who closed his Astenbeck Capital Management last summer, and Texas tycoon T. Boone Pickens, who said this month that he was closing his fund, in part due to declining health.
A spokesperson for Jamison did not respond to requests for comment. In his letter, Jamison said machine learning and artificial intelligence has eliminated short-term trading opportunities for the firm, and long-term, commodities do not offer any obvious benefits. He added that there are wiser places to invest such as master limited partnership (MLP) firms and bitcoin, which he called “digital gold.”
Jamison was down 9 percent last year, according to two other sources familiar with the fund’s returns, driven in part by some losses on natural gas in the second half of the year. Macro commodity hedge funds returned an average of 0.01 percent in 2017, making it one of the worst-performing strategies last year, according to data from industry tracker Hedge Fund Research.
Commodity trading firms and banks posted major losses in 2017 due to muted client activity and wild fluctuations across energy markets. A number of firms were said to have suffered heavy losses in the first half of the year after the slide in natural gas prices NGc1, while others lost money in the second half due to swings in oil prices during Hurricane Harvey. Even Goldman Sachs said the second quarter of 2017 was its worst quarter on record in commodities.
Stephen Jamison, a former Morgan Stanley trader, started the fund in 2009 and mainly invested in commodities, but also other assets when better opportunities arise.
Reporting by Catherine Ngai in New York and Maiya Keidan in London; Additional reporting by Lawrence Delevingne; Editing by Lisa Shumaker Our Standards: The Thomson Reuters Trust Principles.
