Since the onset of the so-called supercycle, around early 2002, commodities have increasingly gained the reputation of being a hedge against everything - except, now, so it seems, commodities.
In the past few days, crude oil prices have surged into unchartered territory, close to $140 per barrel, closer to an as-yet unknown choke point, where oil will demonstrably unleash serious damage on the global economy. Today's oil prices are the highest - in inflation-adjusted terms - seen since the 1860s, an event that triggered the Pennsylvania oil boom. In the modern era, oil crises were seen in the mid-1970s, when prices topped $45 a barrel in today's money, and then $90 a barrel in the early 1980s.
In their most modern manifestation, commodities have also increasingly emerged as a separate asset class, and, when seen as a hedge against everything, offer indirect exposure to emerging markets industrialization, plus as a hedge against inflation. Commodities have also long shown low correlations with risky assets such as equities, and, in recent years, have encouraged diversification-related demand from pension funds and other traditionally conservative investors.
The status of commodities was enhanced when commodity prices survived the turmoil seen since August 2007 - the breaking out of the US subprime mortgage bond crisis - which unleashed serious punishment on financial equities, junk bonds and emerging markets equities.
But can commodities survive each other? And if so, where will oil prices top out, given that oil comprises the biggest weighting of any comprehensive basket of commodities? A number of recent studies have pointed out that a good number of factors offset today's record high oil prices, compared to the crises seen in the 1970s and 1980s - both of which pushed the global economy into recession.
First, interest rates are very different this time around. In the early 1980s, interest rates, which stood at around 16%, were far higher. Today, long dated government bond yields are at 4% in the US and 3.8% for the G7, the world's biggest economies, as a whole. Back in the 1980s, crude oil prices and bond yields were positively correlated, given that expectations were universally pitched to rising inflation.
Bonds were sold off, in anticipation that inflation would rise, and when it did, central banks were forced to hike interest rates. Economies were hit by the double whammy of rising crude oil prices, followed by rising interest rates. Today, by comparison, the world is still smiling, if only just. The US central bank, the Federal Reserve, has cut rates aggressively; core (as opposed to headline) inflation in the US, G7 and across most of the emerging markets world remains steady.
Corporate profitability reports have shown that ongoing globalization and outsourcing has allowed companies to maintain margins in the wake of high and rising energy costs. This, along with corporate restructuring, has prevented a wage-inflation spiral from developing.
What's also different in the modern era is that oil has been rising over a far longer period, at a rate of around 35% a year, since early 2002. In 1973, by comparison, the oil price shot up from about $14 a barrel to around $45 a barrel in just a few months, and in 1979, doubled from $45 to $90 a barrel (in today's money), again, over just a very short time frame. In both cases, the shocks were intense, and the economic fall out was brutal and fierce.
The supply side is also different in the modern era. OPEC has shown little, if any, interest in increasing production, and may not even be able to. That aside, Saudi Arabia, holder of the world's biggest reserves, appears to be happier to keep the stuff underground. Russia, the world's second-biggest producer, has increasingly taxed its oil producers as prices have risen. With little incentive to invest in new capacity, Russian production has been falling off at about 5% a year.
In between supply and demand, OPEC producers and a number of other countries, including China and India, continue to subsidize street-level fuel prices, giving consumers little incentive to optimise fuel usage. There are also physical bottlenecks: overproduction of sour relative to sweet crude oil, given global refinery balances; increasing over-demand for diesel relative to gasoline, given fast-rising sales of diesel passenger autos in Western Europe, and, in deep water drilling, reports that up to 80% of rigs in the world have been taken into service off Brazil.
This is not to ignore a number of tailwinds, led by the credit markets crisis, which remain unresolved, and ongoing real estate deflation, led by the US. A number of analysts, not least at Goldman Sachs, the biggest surviving Wall Street investment bank, and a muscular player in commodity markets, have suggested that oil could be headed to $150 a barrel. Could that be the choke point?
If this number turns out to indeed be the choker, prices may still have one final spike or two. Benchmark crude oils such a NYMEX sweet, light and Brent have flirted with $140; the historic benchmark in the US, West Texas Intermediate, has already traded higher than $140 a barrel.
In the final analysis, the best hedge against commodities is the action - or lack of it - taken by consumers. On the way up, consumers with the willingness and ability to have partaken in investment markets would have been hedging by riding the rising wave of crude oil-related investments: traditional equities, along with proliferating numbers of exchange traded funds and notes, futures, and indices.
SELECTED INDICES, SPOTS & FUTURES
S&P GSCI Enhanced
S&P GSCI GFI-Futures
Baltic Dry Shipping
Baltic Capesize Shipping
Dollar Index Spot
NYMEX sweet, light crude
NYMEX sweet, light crude
Natural Gas (US)
Heating Oil (US)
MSCI New Zealand
MSCI South Africa
Dow Jones Industrial