Commodity prices and the very bullish case for oil (page 1 of 3)

In the past, I have frequently discussed long-term price cycles and observed, based on research carried out by economists such as Nikolai Kondratieff among many others, that these long waves last between 45 and 60 years, with each rising and declining price wave lasting around 22 to 30 years. These long price cycles are well supported by historical price statistics of the 19th and 20th centuries.

The last commodity rising price wave took place between the mid-1940s and January 1980, when gold and silver peaked at $850 and $50 respectively. Thereafter we had a persistently declining price wave, which most likely came to an end between 1999 and 2001 when most commodities bottomed out. I must point out that at that time commodity prices, adjusted for inflation, reached their lowest level in the history of capitalism.

But upon further consideration, while accepting the existence of long price waves for an index of commodities, I have also come to the conclusion that price waves for individual commodities tend to be of far shorter duration. In addition, different commodities move up and down quite independently from each other.

If we look at sugar, for instance, we find that it peaked out in 1974 at 70 cents per pound, collapsed into late 1978, and then soared once again to a high in the summer of 1980. In other words, within less than ten years, sugar went through two huge price cycles before settling down for the next 20 years or so in a price range of between 2.5 cents and 16 cents.

I am mentioning this fact because investors should be aware that commodities can reach a new all-time high and subsequently new lows within a brief period of time, since during the price boom massive additional supplies are produced that later depress prices. Just look at the chart of Soybean prices; the 1997 highs were followed by new lows in 2000!

Even if we assume that the long-term commodity price cycle did turn up in 2001, we should also be prepared to occasionally see 50% declines in the prices of individual commodities within a long-term up-cycle.

In other words, investors who are betting on commodity price increases due to the rising demand from China should be aware that significant downside volatility for individual commodities, even in the context of a long-term commodities bull market, is almost a certainty!

This isn't to say that commodity prices, certain of which have recently seen parabolic increases, will collapse right away. A friend of mine, Richard Strong, once took me to task for being bearish on the U.S. financial markets and asked me why, if Japanese stocks had been selling for 70 times earnings in 1989, the U.S. stock market couldn't reach similar valuations.

Richard proved to be very much on the mark - the Nasdaq sold for even higher valuations in the spring of 2000 than Japanese equities had sold for in 1989. The same rationale could also be applied to the commodities markets.

We could therefore see prices of certain commodities double - or even treble - from their present levels in a speculative mania. This is not a forecast, but a warning to investors of the extremely volatile and short-term nature of bull markets in individual commodities.

There is one commodity, however, about which a very bullish long-term fundamental case can be made: crude oil. Unless the entire Asian region goes into a lengthy recession/depression in the next few years, oil demand will undoubtedly continue to rise.

Oil consumption in Asia, with its population of 3.6 billion people, is about 20 million barrels per day (by comparison, oil demand in the U.S., with a population of 285 million, is 22 million barrels per day).