By Richard (Rick) Mills
As a general rule, the most successful man in life is the man who has the best information
We have crossed a critical threshold. The demand we are now placing on our planets resources appears to have begun to outpace the rate at which they can be supplied.
The gap between human demand on our planet’s resources and the supply of those resources is known as ecological overshoot. To better understand the concept think of your bank account - in it you have $5000.00 paying monthly interest. Month after month you take the interest plus $100. That $100 is your financial, or for our purposes, your ecological overshoot and its withdrawal is obviously unsustainable.
Access to raw materials at competitive prices has become essential to the functioning of all industrialized economies. As we move forward developing and developed countries will, with their:
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Massive population booms
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Infrastructure build out and urbanization plans
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Modernization programs for existing, tired and worn out infrastructure
Continue to place extraordinary demands on our ability to access and distribute the planets natural resources.
Threats to access and distribution of these commodities could include:
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Political instability of supplier countries
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The manipulation of supplies
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The competition over supplies
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Attacks on supply infrastructure
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Accidents and natural disasters
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Climate change
Accessing a sustainable, and secure, supply of raw materials is going to become the number one priority for all countries. Increasingly we are going to see countries ensuring their own industries have first rights of access to internally produced commodities and they will look for such privileged access from other countries.
Numerous countries are taking steps to safeguard their own supply by:
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Stopping or slowing the export of natural resources
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Shutting down traditional supply markets
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Buying companies for their deposits
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Project finance tied to off take agreements
There are several overriding themes effecting the demand for, and supply of, commodities.
Country Risk
Today many governments are looking at ways to get more money from miners as companies report record profits - the higher the returns and the higher the profits, the greedier governments become. As commodity prices rise governments try to boost their share of the proceeds from their countries energy and mining sectors.
In 2011, Resource nationalism became the number one risk for mining companies.
Miners are an easy target as mining is a long term investment and one that is especially capital intensive - mines are also immobile, so miners are at the mercy of the countries in which they operate. Outright seizure of assets happens using the twin excuses of historical injustice and environmental/contractual misdeeds. There is no compensation offered and no recourse.
All of this means increasingly scarce, and accessible resources, are going to become much harder to find and develop - meaning companies with projects in politically stable environments are that much more valuable.
Urbanization
Migration is defined as: the long-term relocation of an individual, household or group to a new location outside the community of origin. Today the movement of people from rural to urban areas is most significant.
Migration cause can be explained two ways:
Push factors - conditions in the place of origin which are perceived by migrants as detrimental to their well being or economic security.
Pull factors - the circumstances in new places that attract individuals to move there.
Unemployed, poor and hungry (push factor) people from rural areas are attracted to cities because cities are perceived to be places where they could make more money and have a better life (pull factor).
Urbanization is a macro-trend, in 1800 two percent of the global population was urban, by 1950 it was 30%. Today half of all the people in the world live in cities. This is an economic migration - historically poverty rates are 4 times higher in rural than urban areas. The UN projects that by the year 2030 there will be 1.5 billion more people living in cities.
Nowhere is this rural to urban migration - and a higher degree of industrialization - more evident today than in China and India.
Out of Control Spending
The US federal deficit in 2011 is a record $1.6 trillion - a number that requires the government to borrow 43 cents out of every dollar it spends. The US government's total debt will mushroom from $14.2 trillion now to almost $21 trillion by 2016.
The 2012 budget projects that the deficits total $7.2 trillion over the next 10 years with the shortfalls never coming in below $607 billion.
The US government cannot sell enough of its debt to its own citizens and foreigners to finance its deficit and pay the interest on its existing debt.
“Yes, we are monetizing debt. You buy bonds and you monetize debt. Right now, a lot of that is going into excess reserves so it is not having an immediate effect on inflation. It will initiate inflationary impulses. It takes time.” Thomas Hoenig, President, Federal Reserve Bank of Kansas City, early March 2011
The US government is already buying its own debt - this is the most inflationary thing a country can do - and it looks like we can expect this trend to continue and probably increase.
Climate Change
The Earth's climate has been continuously changing throughout its history. From ice covering large amounts of the globe to interglacial periods where there was ice only at the poles - our climate and biosphere has been in flux for millennia.
This temporary reprieve from the ice we are now experiencing is called an interglacial period – the respite from the cold locker began 18,000 years ago as the earth started heating up and warming its way out of the Pleistocene Ice Age.
These interglacial periods usually last somewhere between 15,000 to 20,000 years before another ice age starts. Presently we’re at year 18,000 of the current warm spell.
In the 1980s the consensus was that the Earth would experience a steady cooling over the next few thousand years. However as studies of past ice ages continued and climate models were improved worries about a near term re-entry into the cold locker died away - the models now said the next ice age would not come within the next ten thousand years. The earth will continue warming.
Results from the study “Climate Trends and Global Crop Production Since 1980” indicated that from 1981 - 2002, warming reduced the combined production of wheat, corn, and barley - cereal grains that form the foundation of much of the world's diet - by 40 million metric tons per year.
Climate change will impact sea levels and cause an increase in extreme weather events such as floods, droughts and wildfires.
Disease such as malaria, carried by mosquitoes, will spread.
Thanks to decades of warmer winter temperatures the Spruce Bark and Pine beetles have chewed their way through tens of millions of hectares of commercial forests.
Oil
While working for Shell Oil during the 1940's Dr. M. King Hubbert noticed the production of crude oil from individual oil fields plotted a normal bell shaped curve. Roughly half of the oil from a field has been exhausted when the bell curve peaks.
Carrying that insight further he surmised that oil production from a group of oil fields would follow a similar bell shaped pattern.
In 1956 Dr. Hubbert predicted the cumulative group of oil fields within the US would reach peak production in the 1970's, and thereafter decline - no matter how much money would be thrown at exploration and development of reserves US oil production would not rise higher after this date - his prediction was uncannily accurate.
There are a few things we can learn from studying oil production on the upside slope of Hubbert’s bell curve.
As oil production nears its peak:
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Oil becomes harder to find
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Discoveries are smaller and in less accessible regions or geologic formations
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Costs are higher to produce the crude from these discoveries
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Producing oil from existing fields becomes more expensive - recovering the last barrel of oil is more expensive than recovering the first barrel
Mining
Mine production of many different metals is showing a number of similarities:
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Slowing production and dwindling reserves at many of the world’s largest mines
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The pace of new elephant-sized discoveries has decreased in the mining industry
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All the oz’s or pounds are never recovered from a mine - they simply becomes too expensive to recover
There are a few differences between mining and oil:
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Mining is more cyclical than oil which make mining companies even more reluctant than oil companies to spend on exploration and development
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There is no substitute for many metals except other metals - plastic piping is one exception. For oil substitution you have shale gas, coal liquefaction, nuclear power, oil sands, ethanol or bio-diesel, solar, geothermal and wind
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Metal markets are much smaller than the crude oil market so speculation is a larger factor
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There hasn’t been a new technology shift in mining for decades - heap leach and open pit mining come to mind but they are both decades old innovation. Oil producers have exploited new drilling and production technology to produce oil and gas from new types of reserves - oil sands and gas shales.
Food
The term Green Revolution refers to a series of research, development, and technology transfers that happened between the 1940s and the late 1970s.
The initiatives involved:
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Development of high yielding varieties of cereal grains
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Expansion of irrigation infrastructure
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Modernization of management techniques
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Mechanization
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Distribution of hybridized seeds, synthetic fertilizers, and pesticides to farmers
Unfortunately the high yield growth from the Green Revolution is tapering off and in some cases declining. This is in large part because of an increase in the price of fertilizers, other chemicals and fossil fuels, but also because the overuse of chemicals has exhausted the soil and irrigation has depleted water aquifers.
The United States Census Bureau estimates, as of July 1, 2011, the total number of living humans on the planet Earth to be 6.96 billion. By 2050, the world's population is expected to reach around nine billion - minimum and maximum projections range from 7.4 billion to 10.6 billion.
Water
Freshwater aquifers are one of the most important natural resources in the world today, but in recent decades the rate at which we’re pumping them dry has more than doubled. The amount of water pumped has gone from 126 to 283 cubic kilometers per year - if water was pumped as rapidly from the Great Lakes they would be dry in roughly 80 years.
These fast shrinking underground reservoirs are essential to life on this planet. They sustain streams, wetlands, and ecosystems and they resist land subsidence and salt water intrusion into our fresh water supplies.
Almost all of the planet’s liquid fresh water is stored in aquifers. Some of the largest cities in the developing world - Jakarta, Dhaka, Lima, and Mexico City - depend on aquifers for almost all their water.
Water is a commodity whose scarcity will have a profound effect on the world within the next decade - the danger to us from the worsening ecological overshoot concerning the world’s fresh water supply makes the reevaluation of our values mandatory. We will have to drastically change the way in which we view our freshwater as a resource.
Ocean Fisheries
World fisheries are in a state of collapse - caught between plagues of jellyfish, overfishing, nutrient pollution, bioaccumulation of toxics in marine mammals, carbon emissions turning our oceans acidic, the oceans phytoplankton declining by about 40 per cent over the past century, dead zones, garbage patch’s, increasing ocean temperatures and changing currents - our entire marine food chain seems to be in peril.
Populations of jellyfish are exploding around the globe. They feed on the same kinds of prey as fish so if fish numbers are depleted jellyfish fill the gap.
The UN’s Food and Agriculture Organization (FAO) says “The maximum wild capture fishery potential from the world’s oceans has probably been reached.”
Industrial fishing has, over the past fifty years, depleted the topmost links in the marine food chain - worldwide about 90% of the stocks of large predatory fish stocks have disappeared. We’ve been “fishing down the food chain” - as the larger fish disappear we go after smaller and smaller fish.
A United Nations Environment Program (UNEP) report “In Dead Water” published January 2008 said “as much as 80 percent of the world's main fish catch species have now been exploited beyond or close to their harvest capacity.” SOFIA 2010 recorded a rise to 85% in the number of fisheries that are fully exploited or over exploited, depleted or recovering from depletion.
Conclusion
It’s quite obvious urbanization is the driving force behind global commodities demand and inflationary pressures have moved from commodity inflation to core inflation. Both urbanization and inflation look set to continue for the foreseeable future.
The world's oceans are already a mere shadow of what they once were and fish stocks are still dwindling.
“Current estimates indicate that we will not have enough water to feed ourselves in 25 years time.” International Water Management Institute (IWMI) Director General Colin Chartres
The high yield growth in food production from the Green Revolution is tapering off and in some cases declining.
Increasingly we will see falling average grades being mined, mines becoming deeper, more remote and come with increased political risk. Extraction of metals from the mined ore will become increasingly more complex and expensive.
Every country needs to secure supplies of needed commodities at competitive prices yet supply is increasingly constrained and demand is growing. Barring a total global economic collapse or a dramatic reduction in the world’s human population it doesn’t seem to this author demand is going to collapse anytime soon.
This is our reality - we’re living on a relatively small planet with a finite amount of reserves and a growing human population.
Broad spectrum peak commodities is a cause for concern over the longer term.
Junior resource companies, the same ones who today are so oversold and undervalued, are the present owners of the world’s future commodities supply and, most important for investors seeking outsized returns, they act like leveraged exposure (with price gains many times that of the underlying commodity) to the specific commodity(s) investors want exposure to.
Are there a few junior resource companies, with exceptional management teams operating in politically safe jurisdictions, on your radar screen?
If not maybe there should be.
Richard (Rick) Mills?
rick@aheadoftheherd.com?
www.aheadoftheherd.com
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