The Coming Commodities Boom - Redux

Economics, Multilateral Investment Strategies30 Comments

How Investors Can Benefit from BRICS Development Bank Loans and Emerging Infrastructure Development

By JC Collins

Back on October 13, 2015, I published an article which defined the coming commodities boom and the investment opportunities it would produce.  Since that time the Chinese currency has been officially added to the Special Drawing Right composition with an effective start date established for October, 2016.

It has been my conclusion all along that the renminbi would be widely used to fund this infrastructure development with RMB denominated loans being issued through both the BRICS Development Bank and the Asian Infrastructure Development Bank.  I also stated that this would happen at a pace which would surprise many.

Yesterday the Indian President of the BRICS Development Bank, also referred to as the New Development Bank (NDB), gave a public lecture where he further defined the use of the NDB to fund infrastructure development:

“People ask me what is the ‘New’ in the New Development Bank and I say that is the speed of execution. Over and above that, it is a vehicle to enhance South-South cooperation and to provide funds for infrastructure development, as without infrastructure you cannot have industry,” he said.

The article also stated the following:

“Kamath pointed out that emerging countries needed to spend $1 trillion annually to meet the infrastructure needs, but only 10 per cent of that was being provided by the development banks.”

“The NDB would be working closely with other development banks to bridge this infrastructure gap.” (This is likely a reference to the AIIB)

The capital providers we have spoken to are keen on new instruments such as the bonds that we will be issuing, while the central bank governors said that they had no issues if we borrowed in one country and used the proceeds in another country as the $100 billion Contingent Reserve Arrangement has swap mechanisms in place.”

“To mitigate exchange rate risk, the NDB will initially focus on loans and borrowing in the national currencies of the BRICS.”

This is where the importance of establishing the RMB as a reserve currency in the SDR composition comes into play.  The majority of loans will be issued in RMB and will help build the $1 trillion annually needed to meet the infrastructure development goals of the emerging markets.

This will also dramatically grow the RMB liquidity market.

Does anyone really think that commodities are not set for another super cycle?  This is where the investment opportunities are for the average investor.  Mining companies with low debt, commodity EFT’s, and other ancillary services surrounding commodities and the mining sector, will all provide great returns in the coming years.

It’s the old adage of buy low and sell high.  Commodities and many mining companies have been low for many years.  This cycle will begin to change in 2016.

“After the lecture, Kamath told The BRICS Post that the NDB would not be issuing Special Drawing Rights like the International Monetary Fund.”

This was an interesting comment for the President of the NDB to make, and is only relevant in the initial start-up of the institution.  It is my analysis that central banks and other institutions like the NDB and AIIB, will be issuing SDR denominated loans in the future.

The original article on The Coming Commodities Boom is below.

From October 13, 2015:

The time is fast approaching when the normalization of monetary policy must coincide with the necessary adjustments to the international monetary system.  Some of these adjustments have already been taking place behind the scenes with little acknowledgement or understanding of the full scope and scale of the transition.

There has been so much talk about the collapse and corruption of the international monetary system that we have failed to see the adjustments which have already been taking place.  Each nudge and tweak takes place through the movement of markets and capital flows.  What may appear to be happenstance is in fact a well-planned and orchestrated move to re-balance the international monetary framework.

There are five main areas where monetary reforms are focused.  They are:

  1. Global Imbalances (trade surpluses and trade deficits)
  2. Capital Flows
  3. Global Reserve Accumulation (and diversification and substitution of those reserves)
  4. Financial Safety Nets
  5. Surveillance and Policy Coordination

The much lauded economic recovery is not sustainable unless the larger global imbalances are adjusted to account for the five areas of focus above.  It will take the coordination of all countries on all points in order for the imbalances to be corrected.

The imbalances as they stand, hinder the necessary adjustments which are required to correct the imbalances themselves.  The monetary policy of the Federal Reserve on interest rates is one such hindrance on adjustments, which is why the demand for action on increasing interest rates is beginning to increase, including from the emerging markets themselves.

The necessary adjustments are complex and will require a large amount of coordination.  Some of the adjustments concern the deleveraging and rebuilding of private balance sheets in deficit countries.  This point has largely been accomplished by QE policies.

Other areas of focus include facilitating fiscal adjustments where necessary, while encouraging consumption and reducing dependence on exports in surplus countries.  This point has been well covered here through numerous posts on China’s plan to shift from an exporting trade economic model to a services trade model which will be based on domestic consumption.  This is the reason for the development of massive cities in China which are awaiting the movement of rural population.

The adjustments required for trade surplus countries is different from the adjustments required for trade deficit countries.  Some of these differences are found in the savings and investment rates of each, which includes the varying methods to intermediate between borrowers and savers.

The policy choices to address the challenges of surplus and deficit countries will also vary.  The quality of these choices will also vary depending on the country and the dependence on those policies for the purpose of adjustments and re-balancing.

The gaps between these existing policies across the mandates of surplus countries and deficit countries are filled with large capital flows, like we are seeing as the USD strengthens and the impending Fed interest rate increases draws capital from the emerging markets and into American and European banks.

Being that monetary imbalances are best represented by the large deficiencies between surplus countries and deficit countries, it is worth spending some time on better understanding the differences and how they relate to real world economic factors.

Let’s take the collapse in crude prices and compare against adjustments which are required to re-balance the monetary system.  The first thing of interest is that the largest oil exporters are also the countries with the largest trade surpluses.

The top ten oil exporters are Saudi Arabia, Russia, Iran, Iraq, Nigeria, United Arab Emirates, Angola, Venezuela, Norway, and Canada.  All of these countries, except Canada (who has a trade deficit), rank in the top 20 countries with trade surpluses.

This is not surprising when we consider the dominance of oil in the global economy.  But what is interesting is how the collapse in oil prices has benefited the emerging economies.  When we consider that the emerging countries, such as China, India, Malaysia, Indonesia, etc.., will carry the brunt of any Fed interest rate increase, it becomes somewhat intriguing that it is the emerging countries themselves which will benefit the most from the low oil prices.

This benefit will be largely visible in Asian economies, which are the same economies which carried the weight of USD inflation now for decades, such as Vietnam. The benefits will be most realized through an increase in spending on much needed infrastructure development.  The establishment of the BRICS Development Bank and the Asian Infrastructure Investment Bank (AIIB) will be used to fund these massive infrastructure projects while oil prices remain low.

China, who has built up a large strategic oil reserve, will further benefit from low oil prices by making up for slowing industrial growth and falling exports.  As I’ve stated many times before, China is switching from an exporting model to a consumer based model.  The low price of oil, which will support the expansion of infrastructure projects in the emerging countries, will support this adjustment, which will in turn lead to the further adjustments on trade deficits and surpluses between nations.

These infrastructure projects will use vast amounts of commodities, like copper and iron/ore, and eventually will soak up the large crude reserves which have built up over the last few years.  An increase in the other commodities will begin before oil, and will likely begin in the first part of 2016, as the AIIB and BRICS Development Bank begin funding the projects.

The diversification and substitution of USD denominated foreign exchange reserves will also play a vital role in these adjustments.  We are fast approaching the point where interest rates and reserve accumulation will reverse their current trends.  This will mean interest rates beginning to increase, at least in developed countries, and the unwinding of USD denominated reserves into methods of funding infrastructure projects.

This is all being done in coordination, and all countries are on board with the strategy.  The fact that the US has been holding out on specific aspects of reforming the international monetary system, such as the 2010 IMF Quota and Governance Reforms, will only be problematic for a short time longer.  This delay and road block will not last much longer, and could very well be eliminated by the end of the year.

The majority of commodities prices are now at record lows, and considering the large development banks which are beginning to flex in Asia, an area which holds a vast amount of USD denominated assets on reserve, the adjustment of those reserve imbalances can only mean one thing for the price of commodities.  - JC

30 Comments on “The Coming Commodities Boom - Redux”

  1. JC I can only hope you are right again. It seems that recent banning of short selling in China would cause investments to look elsewhere for a free market like the wonderful US. Could strong arming the China market higher propelle their economy to a middle class? Are people going to believe it's not a false hope? Or is it just they have no other choice? Communist Prosperity.

  2. Thank you JC this helps a lot. What would we consider keeping an eye out for to know when commodities are peaking? Maybe a tapering off in infrastructure development in the developing countries?

    Will there be a definable transition when most of the infrastructure is upgraded and the private sector (or industry) begins to take off?

    "as without infrastructure you cannot have industry,”

    Could we learn what happens during an industrial boom by looking at the US's industrial boom or is the multilateral aspect changing it too much for comparison?

  3. Hi JC, thanks again for all you do. I've been following all of your articles and although I now understand 99 percent more than I ever have thanks to you and the PoM family, I'm still behind in so much.Can you share with me how I can go about making small investments in commodities? At this time I have little capital but would still like to make small investments in increments if that is possible. Thanks so much!

  4. The world of ZIRP has led to massive over capacity in metal ores, petroleum, agriculture, etc. The world has infrastructure malinvestment everywhere except broken Africa, so I am having difficulty imagining the source of commodity demand sufficient to offset the current commodity over supply which could lead to a commodity boom. Do you think more 'cheap money' will kick off a new bubble in commodities?

    http://www.indexmundi.com/commodities/

    The link is to charts of commodity prices for decades and they appear to show the collapse of a long term commodities boom occurred in 2008 and then QE temporarily restored demand. The ZIRP QE after 2009 encouraged the massive over capacity noted above. Commodity prices began to fall in 2014 as supply over took demand. World demographics will not sustain demand growth. It looks to me like it may take generations to liquidate the over capacity and the indebtedness of the commodity sector.

    Of course there maybe a nominal boom in commodity prices if you are predicting a hyperinflationary collapse of the dollar. Reference the commodity boom with commodities priced in Brazilian Real!

    1. You clearly didn't read the article, as you didn't reference any of the points I made. Hard to make a counter argument when you don't even understand the original argument. And I don't share your interpretation of the data. Sorry friend.

  5. With trying to stay away from gold .... I'm looking at RIO, AA, and Vale! The most interesting would be Vale given the fall from 28 to 3 (ouchy!!). Being Brazilian they may have the most to gain from normalizing of rates and growth in Asia!

    Am I on the right track ?

  6. "The mediocre teacher tells. The good teacher explains. The superior teacher demonstrates. The great teacher inspires."

    -- William Arthur Ward

    Thank you for being a great teacher JC.

    1. Thank you my friend. That means a lot coming from you. Sorry I haven't been responding as much. I'm doing crazy travel these last few weeks. Sitting in an airport again right now in fact.

  7. JC - I was thinking about the SDR composition etc. and this other thought came to my mind. I don't think you addressed this but if you did, please point me in that direction.

    I understand the composition of the SDR. I also understand the SDR allocations. However, what are the plans for the quantities of the domestic currencies - for the ones in the SDR and also the non-reserve currencies outside of the SDR. Any info is appreciated.

    Thanks

    1. The end goal is the elimination of foreign exchange reserves all together. The broader use of the SDR will facilitate that elimination. When thinking of SDR and domestic currencies, consider the amount of currency in the foreign exchange reserves which will have to be substituted and/or diversified.

      1. I like to think of it as a shifting of liquidity. Watch for a balancing of reserves and liquidity between the three main reserve currencies - dollar, euro, and yuan.

    1. See todays post in the Bank of Canada announcement. The rest of the world is where the US was in 2008. Massive QE and ZIRP will not be allowed on an international level. This could be one of the catalysts for broader monetary reform. I always keep thinking of the shifting of liquidity.

  8. old news update:

    RMB adoption between China and Japan has more than doubled in the last two years
    01 Dec 2015
    "...Although the Japanese yen retains its top position as the number one currency used for payments between Japan and China/Hong Kong, the RMB is gaining traction in this corridor. In the last two years, the RMB has jumped from position four to position two, overtaking the Hong Kong dollar and the US dollar..."

    yet another example of increasing demand for RMB trade settlement.

  9. "The Asian Infrastructure Investment Bank (AIIB) will open in mid-January next year, said Chen Huan, who is in charge of preparations for the bank's launch."

    http://news.xinhuanet.com/english/2015-12/03/c_134882179.htm

    And

    "The Asian Infrastructure Investment Bank, the new international development bank led by China, plans to lend $10 billion to $15 billion a year for the first five or six years, a top official said on Tuesday."

    Jin Liqun, president-designate of the Asian Infrastructure Investment Bank goes on to say,

    "The bank is neither a Chinese bank nor a bank owned by the Chinese government, but one owned by all participating countries,"

    "The bank has already initiated talks with other institutions, including the ADB and the World Bank, said Jin."

    http://www.chinadaily.com.cn/bizchina/2015-12/02/content_22598637.htm

    **********************************************

    "The Asian Development Bank estimates the region will require $8 trillion in new infrastructure by 2020."

    "The World Bank has $223 billion in available funds but only 15 percent of its lending is directed toward Asia." (15% of $223b is $33.45b) "The Asian Development Bank had $153 billion in capital at the end of 2014."

    http://www.bloombergview.com/quicktake/chinas-world-bank

    This in addition to the Triffin Paradox the financial need becomes pretty obvious. More on the Triffin Paradox can be found here.

    philosophyofmetrics.com/wp-content/uploads/2015/11/The-Economic-Transition-Papers-Re-Engineering-the-Dollar.pdf

    https://www.google.com/webhp?sourceid=chrome-instant&ion=1&espv=2&ie=UTF-8#q=site:http:%2F%2Fphilosophyofmetrics.com%2F+triffin

  10. JC, Thank you for another well thought out and focused article. What would be your thoughts on Japan. Sitting right in the middle of Asia but strapped with massive debt. Would your thoughts be more in line with Kyle Bass, who has nothing but doom to report about Japan? Or do you see a Japan benefit from this new Asian development boom?

    1. I see Japan being abandoned by the west but embraced by the east. Their debt problems will be considered as a regional Asian issue, with some USD denominated reserve diversification.

  11. I hope you and yours are doing well JC. We miss you. I know you are really busy right now. I admit that I'm really looking forward to your next comments/article. It's nearly Xmas and the Santa rush is on. Take care mate, look forward to hearing from you soon.

  12. Hi Alan,

    Glad to see I'm not the only one checking in eagerly awaiting the next instalment! The next commodities boom looks like it might be something the average person can really take part in with prices being beaten down to almost nothing. If JC is right about gold and oil either staying neutral or drifting lower, some companies and fund will see amazing gains while others will look left out. Currently watching everything in the sector getting crushed.

    1. Hi silverboxervancity, I'm glad you're here.

      Glad to see I’m not the only one checking in eagerly...

      It certainly is an exciting month. I'm also glad you're still here JC 🙂

      Fed rate hike. AEC officially launched. AIIB begins operations. The next 4 to 5 weeks are jam packed with PoM nuggets.

    1. awesome @Dane. I really look forward to your comments and links. Time is the greatest commodity mate, so thanks for sharing yours with us. Your efforts and research contributions are appreciated by this fellow 🙂

      1. Thank you Alan. I have to say you've kind of shown me how to elevate my game so a thank you goes out to you also.

        The fellowship here on POM energizes me. Its like soul food.

        Teamwork allows the dream to work.

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