London Manager on Low Wheat Inventories, Mass Urbanization, OPEC
'Commodities super cycle' is not a marketing gimmick

From Benedicte Gravrand, Geneva: Chris Brodie is the senior fund manager of the Krom River Commodity Fund and has 14 years of commodity trading experience. The fund itself is a discretionary pure multi-commodity fund, producing alpha in all market cycles, fundamentally and technically driven with transparent risk management. It was launched in June 2006, is domiciled in the Caymans and manages US$60 million. The June 07 NAV was at 119.43. The fund is soft-closed throughout August and September, during which time the managers are reassessing its positions as the AUM has grown significantly since inception, but it will re-open in October. Mr. Brodie gave his views on matters that bring home some real concerns.

Low inventories

“The grain inventories have just about halved since 2000 from 600 million mt to 300 million mt. In terms of days, inventories globally are at almost record low levels since 1960. This year for example, corn acreage increased by almost 12 million acres and yet next year, due to increased demand from the ethanol refiners, corn acreage will have to be increased again - this time by about 3 million acres. This will be difficult as there will also be a need to increase soybean and wheat acres. The central issue of the grains markets is not about supplying a certain crop; it is about not having enough acres to meet total demand.”

Indeed, Dow Jones reported on Wednesday that with wheat futures hovering within 75-85 cents of all-time record highs, some market analysts have recently been advising growers to actively sell their 2007 production and hedge future wheat crops, as well. "Wheat is currently trading at the highest price in history for this time of year," said analyst Bob Utterback. "We believe all wheat producers must be looking at multiple year sales now."

Exposed situation

“The theme to focus on is not the individual market but the individual conditions. The conditions in a boom market are low inventories where supply problems cause price explosions. Now in the grains, we have low inventories and high prices in grains like wheat and soy beans; high demand means we have reached low inventories and high price ranges despite the fact that we have not yet had a severe drought. If we now have even a mild drought we have a serious food problem on our hands.”

Ethanol: close to the price of unleaded

“Ethanol will be priced off petrol as essential substitute. Therefore give or take some problems in the wheat distribution, it should be very close to the price of unleaded petrol plus the actual benefit from any incentives.”

Mass urbanisation

According to the U.N., 2007 is the first year in human history in which more people live cities than in the countries. Mass urbanisation is a phenomenon that many decry as disastrous. Not Mr. Brodie. “It is an interesting concept that explains a lot. Mass urbanisation involves moving subsistence farmers who are not really economically interacting with the rest of the economic universe into cities. Urbanised, they become producers and consumers and develop an economic footprint. The more urbanisation you have, the greater the impact it has, not only in that specific country, but globally.”

It is a virtuous cycle

“The interesting thing for me is that mass urbanisation leads to stronger economic growth cycles requiring additional workers creating more economic growth; it is a virtuous cycle – it feeds on itself. The consequence of mass urbanisation is that the economies grow at a rate which is higher than demographics would normally suggest. That is why globally the world has been doing extremely well over the last 7 or 8 years. It is not just a question of China or of India, but it is about all the other developing countries as well. This year is the first year in human history when more people are living in towns and cities than to the countryside.”

Impact of growth on commodities

“These people are suddenly very big consumers of commodities. How long is this going to go on for? Probably to around 2020. Which means that the commodity demand growth is going to go on a lot longer and stronger than previously thought. One of the interesting facts that came out of a recent Bloomberg conference was that the average wage in India today is US$2 a day and in China US$5 a day. If you think that we potentially have a dozen years of growth ahead due to mass urbanisation, and if you consider that the commodity prices at the moment are extremely stressed even though the average wages are low it makes you understand exactly what sort of impact this growth is going to have on commodities.”

Super-cycles

“When I first heard of the world super-cycle, I thought it was a marketing gimmick. The more I look into it the more I buy into the concept. People who don’t believe it, I think, don’t understand the concept of mass urbanisation and its impact on the global economy.” A commodity super-cycle is a long period of higher prices.

In the same line, Francisco Blanch, Merrill Lynch’s head of global commodities research recently said to the Financial Times that “there are many differences between the commodity super-cycle of the 1970s and the current commodity super-cycle: monetary policy has been more accommodative despite the commodity price increases, we have not seen any major commodity supply shocks yet (such as the one created by the Iranian revolution 27 years ago), there is less scope for commodity demand substitution, and there is no massive investment program in the horizon that could create a significant productive capacity overhang over the next five years. Moreover, demand for commodities from emerging economies is incredibly strong and incredibly resilient, given the high prices… given the limited growth in supply across most markets I believe that oil, gold and grains prices will still have to increase substantially from the current levels in the next 10 years to slow down the healthy demand growth from emerging countries.”

"I am still friendly towards the price of oil"

“The demand for oil within OPEC is growing faster than the production of oil in OPEC. That explains why over the last few years, OPEC production has increased substantially but have not actually managed to increase exports substantially. Today, demand for oil is a million barrels a day higher than last year, but production is a million barrels a day less. What that is telling you is that you should expect oil prices to remain stressed while inventories remain low and vulnerable to supply disruptions. In other words, I am still, even at these prices, very friendly towards the price of oil. One of the interesting things about oil, is the way the way the market pricing has changed from a contango to a backwardation on WTI. That is telling you the market is a lot more prone to volatile prices.”

“Mass urbanisation leads to higher global demand for all commodities - including energy; as a result, if energy prices stay, high grain prices will remain high as well.”

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Reprinted with permission from Opalesque Alternative Market Briefing.