Commodity price inflation is both a social and an economic issue. In emerging markets in particular, food and energy costs take a deeper slice out of consumers’ income, which can lead to the type of unrest that causes governments to topple. In addition to the potential impact of extreme weather on food supplies, central banks around the world are printing a flood of money, which could lead to inflated prices for other goods and services. As investors, our job at Templeton is to search for individual companies that show potential ability to survive and thrive in the face of challenges. I believe long-term emerging markets demand for commodities is likely to keep growing, so my team and I continue to hunt for companies we believe are attractive investment opportunities as a result of commodity demand. Among investment themes, we believe emerging-market growth has the potential to create a long-term bull market for commodities, and could lead to related opportunities, particularly in areas such infrastructure construction and the energy sector.
In 2012, slowing global growth kept inflation in check in many economies, allowing for expansionary monetary policies. Unfortunately some emerging markets had to stomach an unpalatable combination of rising inflation and slowing growth in their economies, tying the hands of central bankers. India was one case, enduring a GDP growth slowdown. And, the late arrival of India’s monsoon rains threatened crops and caused price spikes in vegetables and other key crops such as lentils and edible oils.
Elsewhere, Mexico saw its annual inflation rate hit a 2 ½-year high in the fall of 2012. Prices skyrocketed in foodstuffs including eggs, chicken and corn, the latter of which hit a record high per bushel on the world market amid drought conditions in the U.S. Mexico imports about 20%-30% of its corn, so higher U.S. corn prices can lead to higher tortilla prices, a national staple. Corn, of course, is also used globally for feeding livestock and for fuel (ethanol), so tight supplies can have ripple effects in many markets.
Energy and Metals
The energy and metals sectors also felt the strain of supply shortages in 2012. Through my recent travels to China, India, Africa and other parts of the emerging world, one clear trend I’ve noticed is a rise in traffic congestion. More and more drivers are hitting the roads, and I don’t see demand for cars slowing anytime soon. Global auto sales are expected to hit 83 million in 2013.1 As a result, my team and I are likely to continue seeking investment opportunities in the energy sector, particularly in diversified oil companies, until there is a viable alternative to fossil-based fuels to power vehicles.
Looking at the ripple effects of the emerging markets transportation boom, an increase in traffic typically means an increase in pollution. Catalytic converters using platinum and palladium can help alleviate vehicles’ toxic emissions. We believe those metals could see increased demand in the use of autos, as well as for other industrial applications, and don’t forget—jewelry too.
Likewise, nearly every modern dwelling contains copper (for plumbing, wiring, etc.), and there is concern that increasing demand may mean supply shortages this year. While the U.S. and Europe saw housing and construction go bust in the wake of the 2008-2009 financial crisis—and still haven’t completely recovered—there are places in the world where housing and construction booms are underway.
The supply situation is of particular concern because many natural resources are becoming harder to find and extract, and in some countries, there are added constraints from protectionist policies. For instance, in the global mining industry, we’ve seen increasing signs of government pressure to take a larger share of mining profits. Activism has also risen as workers demand higher wages—violent clashes at mines in South Africa last year being a prime example. In addition, more incidents of environmental protests can lead to a situation where mineral supplies may not keep up with demand.
Another case in point is Peru’s mining industry. Although by some estimates mining accounts for 20%-30% of the country’s tax receipts and about 60% of its exports, there are many forces that have constrained output. Billions of dollars’ worth of mining projects were delayed last year as a result of violent opposition concerning water depletion in underground aquifers. This means that mining companies will need to undertake the expensive process of desalinating seawater in order to get the needed water supply.
We believe the end result of these developments, which we’ve seen echoed in other mining regions around the world, could be potential shortages of key minerals and metals, which can lead to higher prices.
I also believe demand for gold could continue to increase, given that the money supply has increased dramatically in most major economies (including the U.S., Europe, Japan and China). Consumers desire gold not only for its beauty, but many investors view gold as an inflation hedge or a way to store wealth. We’ve also seen central banks globally adding to their gold holdings recently.
Often people will witness a decline in various commodity prices at any point in time and assume that the threat of inflation has passed. However, commodity price moves are often caused not by the fundamentals of long-term supply and demand, but by short-term speculation that surrounds the trading of commodities—typically based on the most explosive news headlines of the day. It looks to me that the long-term demand trend for commodities overall should continue to move upward. When we have countries like China, India and others in the emerging and frontier markets growing at a strong pace, it’s reasonable to expect an increased need to power and produce more.
Still, this rising tide won’t necessarily raise all ships. I don’t see every commodity experiencing greater demand, and demand growth won’t likely be uniform. While I can’t predict when a correction will or won’t occur in these markets, one thing I think we can count on is volatility. The trick is correlating trends to opportunities, which is, as always, what my team and I strive to do through our in-depth research.
1. Source: WardsAuto, 2013 Automotive Outlook International.
Important Legal Information
Investing in the natural resources sector involves special risks, including increased susceptibility to adverse economic and regulatory developments affecting the sector. The prices of such securities can be volatile, particularly over the short term.