Commodities are a very simple investment; if supply is tight, prices usually rise. The Commodity Research Bureau (CRB) index tracks the price of a basket of commodities including metals and grains although it is heavily weighted to energies.
In the 1960's this index pottered along doing very little until the early 1970's when we saw a huge increase in demand for metals and energy from Japan and the West. Car sales and demand for building materials rose as huge new cities expanded to take in people from rural areas. In addition, demand for energy intensive consumer goods increased. Suppliers of these resources could not cope with this new demand and prices rocketed. Disruption to supply caused many price spikes. Many “developed” countries saw blackouts and energy rationing. These rising prices made new projects economically viable and by the early 1980's, supply was matching demand and prices started to gently retreat. In 1999 prices for this basket of commodities fell to the same level as those in 1974; this does not take into account inflation, which was rampant during this time. In real terms prices had hit an all-time low. With this in mind supply fell, it became no longer viable to produce these commodities. Budgets for those still operating were savagely cut and therefore exploration, modernisation and recruitment spending was non-existent.
Low interest rates in the aftermath of the 9/11 attacks and the tech-stocks bubble encouraged another round of consumer goods purchases in the Western world. China and India hold one third of the world’s population and they had the workforce to produce these consumer goods at a very low cost. We therefore saw huge trade surpluses as they exported their goods and services all over the world. These surpluses were ploughed into infrastructure, especially in China but also in India, Russia and Brazil. Remember these countries did not see the development that the Western world saw in the 1970's and 1980's. This demand took nearly everybody by surprise, especially after years of chronic underinvestment.
Inventories for most commodities fell during this time as large infrastructure projects across the globe took shape. Before the industrialisation of the emerging markets really had a chance to get started, the credit crunch hit and sent demand tumbling; nearly everything was put on hold. For commodity prices this was not like the slow grind reduction that we saw in the 1980's and 1990's, this demand destruction caused prices to drop precipitously; the CRB index fell 54% in 8 months, back to the same levels seen in 1973!
Following the credit crunch, funding for high cost/high risk projects, such as commodity exploration, became incredibly difficult to ascertain. This has delayed much of the new supply coming to market. Following the global recession and recent sovereign debt crisis lending is still tight and the low base rates are still not being passed on to businesses and consumers. Couple that with robust demand from the emerging markets and we look to be heading for a strong demand, weak supply scenario again. Now we are in a period of uncertainty over Eurozone stability, have just entered another round of stimulus and see persistent concerns over geopolitical concerns in many oil-rich nations, there may be many more reasons to hold commodities than the simple supply demand fundamentals that have been so constructive thus far.