Michael SchwartzThe United Nations issued a press release this week stating that the world population, which is close to 7 billion right now, will surpass 10 billion by 2100.  Many analysts had believed that population growth would stabilize at around 9 billion globally.

The news reminded me of an extremely interesting newsletter authored by Jeremy Grantham of GMO, titled “Time to Wake Up: Days of Abundant Resources and Falling Prices Are Over Forever.”

The main thesis of Mr. Grantham’s newsletter is that “the world is using up its natural resources at an alarming rate, and this has caused a permanent shift in their value.” The prices, in real-terms, of all important commodities other than oil have fallen by an average of 70% over the last 100 years until 2002.  From 2002 until now, the entire decline has been erased.  “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.”

Commodity Index Chart

Here are a couple of key facts noted in the newsletter:

The world population was 800 million in 1800 and we’re on our way to 10 billion 300 years later.  On top of the population growth we are seeing “explosive growth in developing countries that have eaten rapidly into our finite resources of hydrocarbons and metals, fertilizer, available land, and water.”

“Despite a massive increase in fertilizer use, the growth in crop yields per acre has declined from 3.5% in the 1960s to 1.2% today. There is little productive new land to bring on and, as people get richer, they eat more grain-intensive meat. Because the population continues to grow at over 1%, there is little safety margin.”

The chart below demonstrates that most commodities are not on the same downward price trend that has existed for the last 100 years.  For example, there is a 1 in 2,200,000 chance that Iron Ore is still on the same trend line.

Paradigm Shift Table

We’ve heard this before haven’t we – that the world will use up all its natural resources – the loudest of all being the “peak oil” theorists.  Here’s what Mr. Grantham has to say about previous forecasts:

“Aware of the finite nature of our resources, a handful of economists had propounded several times in the past (but back in the 1970s in particular) the theory that our resources would soon run out and prices would rise steadily. Their work, however, was never supported by any early warning indicators (read: steadily rising prices) that, in fact, this running out was imminent. Quite the reverse. Prices continued to fall. The bears’ estimates of supply and demand were also quite wrong in that they continuously underestimated cheap supplies. But now, after more than another doubling in annual demand for the average commodity and with a 50% increase in population, it is the price signals that are noisy and the economists who are strangely quiet. Perhaps they have, like premature bears in a major bull market, lost their nerve.”

Even with the paradigm shift and long-term trend of rising commodity prices, Mr. Grantham forecasts, with an 80% probability, that commodity prices will come down next year.  The two key drivers are a better weather year (this last year was the worst in decades), and a slowing of China’s economy.  If one of these events happens, “commodity prices will decline a lot.”  “If both events occur together, it will probably break the commodity market en masse” and “produce the second ‘once in a lifetime’ (investment) event in three years.” But this doesn’t change the long-term trend – “in the next decade, the prices of all raw materials will be priced as just what they are, irreplaceable.”

Have we really reached a paradigm shift?  I won’t pretend to be the expert, but what seems very clear is that we have a growing global population with more “western-like” appetites in food and consumer goods.  And commodities are getting harder and more costly to get out of the ground whether it is oil from tar sands in Canada or iron-ore from less developed regions like Zambia.  I absolutely believe we will have higher commodity prices at the end of this decade than we do now.  In addition to higher prices, we will see more and more volatility caused by a tighter demand/supply equation.

Where Mr. Grantham sees this as an investment opportunity, I see it as an opportunity for corporations to put best practices and systems in place to better manage commodity procurement.  The organizations that figure this out first will have a big competitive advantage.

Michael SchwartzThere was a very interesting article in The Times about industrial manufactures raising prices due to the soaring cost of raw materials.

I’ve noted in the past about Food and Beverage companies being affected by rising and volatile commodity prices – and the news continues – McDonald’s CFO, Pete Bensen, said on a recent earnings conference call that it will raise prices this year in the face of rising commodities costs.

But I haven’t seen many articles about the effects of rising commodity costs on industrial manufacturers.  The Times article presents a call-out case study of Norton Motorcycles.  “A motorcycle is constructed 60% (by weight) from aluminium, 20% from steel, and the remainder from a combination of plastics, rubber, paint and other materials.”

The article also lists the cost increases for these materials in the last year:

  • Rubber (tires) 73%
  • Steel (frame) 29%
  • Aluminium (engine casting) 8%
  • Plastic (fuel tank) 7%

lan McCafferty, the CBI’s chief economist, said: “Manufacturers have come under intense pressure to pass on rising costs. They have increased prices markedly in this quarter and expect to raise them at an even faster pace over the next three months.”

The publication of the article couldn’t have been more timely; Triple Point recently published a solution brief, “Commodity Management for Automotive Manufacturers and Suppliers,” in order to help manufacturers operate in this environment.

The focus for supply chain groups over the last 15+ years has been on efficiency and speed. Manufacturing and supply chain techniques such as — Just in Time (JIT) inventory management, Total Quality Management (TQM), Six Sigma and Demand Driven Supply Network (DDSN) — were introduced to eliminate waste, reduce inventory and improve quality. These efforts have led to a striking reduction in buffer inventories to bare minimum levels. In addition, these leaner supply chains have become more global as organizations look for lower cost suppliers and new markets to sell product. On one hand, this has reduced costs and opened new markets but on the other hand it has significantly limited the ability of businesses to handle unforeseen shocks to the system such as sharp raw material price rises and volatility.

The Triple Point solution brief discusses how automotive manufacturers and suppliers (really applicable to all industrial manufacturers) are facing unprecedented fundamental changes in metals, chemicals, plastics and energy market environments.  In this “new-normal,” industrial manufacturers need to recognize how the same systems that have historically been deployed by energy and commodity trading companies can help them manage raw material risk and preserve profit margins.


Page 1 of 1