Analysis: Commodity boom long lasting

If you thought the global commodities boom was running out of puff, think again. The latest analysis shows that this is not really a boom at all, it is the biggest economic revolution in the past 100 years.

Jeremy Grantham, a U.S.-based economist famous for his study of price bubbles, has stunned his followers by declaring that "the days of abundant resources and falling prices are over forever".

If anyone other than Grantham had said that then he would accused of being a naive optimist who failed to understand economic cycles and the immutable force of Adam Smith's invisible hand which dictates that supply always rises to meet demand.

But Grantham has said it, and a lot more, in his latest GMO quarterly newsletter which is sending a shiver through North America and Europe but will bring broad smiles to commodity-rich parts of the world, including Australia.

Essentially, Grantham acknowledges that the world's booming population, and the growing aspirations of Asia's billions, has reversed a 100-year slide in commodity prices, and breathed fresh life into the once discredited predictions of Thomas Malthus.

More on Grantham's analysis later, first a bit on the man, and why his thoughts are important. For much of his illustrious career Grantham stuck to a belief that all asset classes eventually "revert to their mean" - economist speak for when the price of something rises too fast it will eventually return to its long-term price trend.

Australian property investors hate Grantham because he is the man who last year predicted that prices here would crash by up to 50% because they had risen too far above their long-term trend.

Given that the investment company he co-founded, Grantham Mayo Van Otterloo (GMO) has around $US107 billion under management, and he has made fortunes for GMO's clients by spotting bubbles then it can be expensive to ignore Grantham's views on bubbles.

But, what to make of his commodities analysis which appears to fly in the face of his famous bubble spotting? In a few words: Grantham has changed his tune, as expressed in this astonishing observation about his new speciality of "regret minimisation" and a personal investment commitment to buy more "stuff in the ground".

What Grantham has seen is that the impact of the world's population rising from 800 million in the year 1800 to 7 billion today is putting unbearable demand pressure on the price of all commodities - a classic extension of the Malthus argument that the world would eventually have too many mouths to feed.

Grantham's argument is more scientific than that and starts with China's role as the consumer of immense volumes of commodities, such as 53.2% of the world's cement, 47.7% of iron ore, 46.9% of coal, 40.6% of aluminium, and 38.9% of copper.

He has then generated an updated version of his GMO commodity index which tracks 33 important commodities (such as coal, iron ore, fertiliser, gold, wheat, wool and rubber) to demonstrate that the index has returned to a level seen only three times in the past 100 years - once during and after the first world war, then after the second world war, with the last being the oil-price inflation shock of the 1970s.

This time, Grantham reckons the rise in the GMO index is different. It is, he says, a "the great paradigm shift" because the world is not producing enough food and minerals to satisfy demand.

"The prices of all important commodities except oil declined for 100 years until 2002, by an average of 70%. From 2002 until now, this entire decline was erased by a bigger price surge than occurred during world war two," Grantham wrote.

"Statistically, most commodities are now so far away from their former downward trend that it makes it very probable that the old trend has changed, that there is in fact a paradigm shift, perhaps the most important economic event since the industrial revolution.

"From now on, price pressure and shortage 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."

That's why Grantham's analysis is seen as gloomy in North America and Europe, and why there will be a reverse reaction in commodity-rich countries such as Australia.

Rather than deal with shortages and high prices, we'll have to learn to deal with high demand for our "stuff in the ground", a soaring currency, and ever-tighter skills shortages.