Slider, your post made me think (yeah I know that's the idea etc.) and since I'm home with a sick kid today I have time to write a bit. The question is not what does the herd think or what does the Fed think. The question is what do big investors/speculators think? Not that I know any such people, but I'll use my imagination.
They got into commodities several years ago because the prices were ridiculously low.
They stayed in commodities 2003-06 because the world economy was booming and commodities went up with it.
But why have they stayed for the past year when the economy is clearly slowing down? The usual reason we hear is that Asia is not slowing down yet. Is that a good enough reason?
We all know Asian growth is based on lower cost to produce goods and services. From 2003-06 we had low interest rates and economic growth, and yet no price inflation because of cheap Asian labor. This economic growth drove up commodity prices. This is not just because demand grew, but because supply could not keep up. Why not? Here is where it gets interesting.
I am not talking about peak oil or South African power outages. I want to write about the nature of the commodity business, something not well appreciated by those who have never worked in natural resource industries. The term "commodity" is practically synonymous with a low-tech, low-margin product that can be produced anywhere with cheap labor. But this doesn't describe gold, oil, iron, wheat, or any major natural resource commodity. Chinese companies cannot produce oil any cheaper than American companies. It's not about cheap labor. Every person on an ocean drilling platform earns six figures, regardless whether the rig is located in Texas or Nigeria.
And these are not low-margin businesses. Here is a list of the profit margin of some industry-leading companies.
Companhia Vale Rio Doce: 36%
Microsoft: 29%
Barrick: 17%
Pfizer: 17%
Apple: 15%
GE: 12%
Goldman Sachs: 11%
Exxon: 10%
Berkshire Hathaway: 10%
Toyota: 7%
Wal-Mart: 3%
Citigroup: 2%
Fannie Mae: -4%
CVRD's main product is iron ore pellets, and it's profit margin is 36% on revenue of $32 billion. CVRD, Barrick, and Exxon all have margins equal to or higher than Berkshire Hathaway.
So where would you put your money? As the economy slows, who is going to feel the pinch first? Those with low margins or high leverage. Who still has pricing power, a high barrier to entry, and cash in the bank? Natural resource industries. I'm not saying commodities are immune to a recession. But it makes sense that they should be the last domino to fall.
Fun-da-Mental |
