Do rising commodities prices signify a world of change?

Brazil is one of the biggest beneficiaries of the commodities boom and the huge demand for resources from Asia. Thirst for the world's commodities from China and other fast-growing emerging markets has led to soaring exports of Brazil's natural riches – including iron ore, ethanol and soya – and has helped to swell the country's trade balance. The impact of rising commodity prices on Brazil's economy is startling: replace 2011 prices with those from 2005, and the country's $23bn trade surplus would swing to a $20bn deficit.

With its commodity economy booming, the Brazilian real has become one of the most overvalued currencies in the world, and imports have boomed to serve an increasingly wealthy population. The darker side of this boom is the growing threat to the country's manufacturers; these are feeling the pressure of cheap Chinese goods and have appealed to the government for support for domestic businesses.

The commodities supercycle

Geopolitical unrest in the Middle East and north Africa, the earthquake in Japan and the sovereign crisis in Europe have all given greater momentum to the commodities supercycle, which was only temporarily stalled by the financial crisis. Oil prices have pushed sharply higher as Libyan supplies were cut and risks to the region's oil production rose. This trend was compounded by Japan's growing reliance on imported oil, gas and coal in the face of the crippling of its nuclear industry.

The events in Japan will affect more than energy markets. As the country turns to reconstruction in the wake of the devastating tsunami, most analysts expect this to push up demand and prices for other commodities, such as iron ore, copper and zinc.

Differing opinions

There is significant disagreement about what these trends mean for the global economy and rising inflation. In the final week of April, as gold hovered near its all-time high of $1518 an ounce and US crude oil traded just shy of the three-year high of $113 a barrel achieved a few days earlier, US Federal Reserve chairman Ben Bernanke was sanguine about commodity prices. In a statement about the country's interest rates and plans for the Fed's $600bn quantitative easing programme – expected to end in June – Mr Bernanke maintained that inflationary pressures are “subdued” and that pressures from energy and other commodities are “transitory”. 

However, Mr Bernanke is an increasingly lone voice. In an editorial for the Financial Times newspaper at the beginning of February, Roger Jones, global head of commodities at Barclays Capital, outlined his view that the commodity supercycle is back in full swing. The sector, which usually performs best in the latter stages of economic recovery, is bucking that trend, with demand for many commodities hitting all-time highs last year; the growth in oil demand in 2010 was the second strongest of the past 30 years, while global copper demand increased by 10%. While he believes this year will be a volatile one for commodities, Mr Jones is convinced that demand will outstrip supply and that high commodity prices are here to stay.

Mr Jones' view is shared by Jeremy Grantham, co-founder and chief investment strategist of Grantham Mayo Van Otterloo (GMO), a Boston-based asset management company with $107bn in funds under management. Mr Grantham is particularly noted for his prediction of various bubbles, and in GMO's quarterly letter to investors in April, he argued that the world is witnessing the most important economic event since the industrial revolution.

“Accelerated demand from developing countries, especially China, has caused an unprecedented shift in the price structure of resources: after 100 years or more of price declines, they are now rising, and in the past eight years have undone, remarkably, the effects of the past 100-year decline. Statistically also, the level of price rises makes it extremely unlikely that the old trend is still in place... From now on, price pressure and shortages of resources will be a permanent feature of our lives. This will increasingly slow down the growth rate of the developed and developing world and put a severe burden on poor countries.”

Inflection point

Mr Grantham offers plenty of evidence to support his thesis that the level of sustained compound growth experienced in some countries cannot continue with the world's finite resources: he shows, for example, the surge in population over the past century and the historical prices of a huge range of commodities. His conclusion is that “we are in the midst of one of the giant inflection points in economic history. This is likely the beginning of the end for the heroic growth spurt in population and wealth caused by what I think of as the hydrocarbon revolution rather than the industrial revolution. The unprecedented broad price rise would seem to confirm this.”

And the highest level of compound growth that Mr Grantham thinks could be maintained for a few thousand years? He suggests just 0.1% and even that would at some point break the system.