The long, mid and short-term cycle view of commodity investing...
MIDWAY THROUGH a 30-year generational cycle, commodity investments are getting long-in-the-tooth on the mid-term 10-year cycle, reckons Scotty George, chairman of du Pasquier Asset Management.
Here he also speaks to Hard Assets Investor about the short-term outlook and impact of interest rates on depleting natural-resource prices...
Hard Assets Investor: You're a long-time asset manager in equities and fixed income. Are commodities and raw materials a new focus on your part?
Scotty George, chairman, du Pasquier Asset Management: Well, our primary bias is what one might call a quantitative review of the markets; that is, trying to measure and calculate sector rotation where money flows, how quickly, to what degree and what magnitude, and certainly for what period of time, duration. We've been moving into these hard asset classes now since the demise of the dot-com revolution.
HAI: So you got in fairly early...
Scotty George: I was writing pieces in 1996 and '97 called "Below the Fertile Fields", which was an allusion at that time to the speculation and boom that was taking place in capital values in technology, and the fact that money – at some point – was going to have to rotate back into the back end of the market cycle.
We didn't invest during that period of time. But we were early to begin transferring assets out of the speculative bubble, and starting to find new areas of opportunity and industrials, and then, of course, into the tangible assets, which we've been investing in now for about 12, 15 years.
HAI: How does the commodity-sector look to you now?
Scotty George: Let me divide that question into three parts. Over the very long term ? which would be the generational cycle, the 20- and 30-year market cycles ? we're probably midway through the emergence and boom in tangible assets; pricing pressure, the depletion of natural resources, and particular sectors that we'll talk about this morning.
In the intermediate term ? over the last 10 years, that is, since the 2002 bull market ? we've run a long course. And it's beginning to look a little bit exhausted in terms of that cycle presence. And over the short term ? which we would probably categorize as the rally in hard assets from this past summer ? I don't think there's any question in my values that these sectors have come quite a long way.
So what we're looking at, to break it down into those three components, is a probable capitulation to the downside in the short run; a pause in the intermediate term; but a continuation of this very long-term trend that I think has a lot more to go.
HAI: How much of the short term and intermediate is dependent upon global monetary and fiscal policy – things that a lot of the bullish camp has been saying fueled the whole thing?
Scotty George: Well, I think the policy affects more so the short term than any other of the cycles that I measure. As news events occur ? whether they be daily or intraday, weekly or longer ? you see money flowing in and out of all kinds of securities. It's not just the commodities. And that affects these price pressures, these pushes, these valuation expansions that occur over a short term. So the summer rally, I think, was really pinned on the election; it was pinned on people's insecurity about fiscal policy. It continues to this day, even though these values have expanded.
Policy does not, however, influence long-term secular cycles, whether it be interest rates or commodities. These are, as you referred to, demographic trends. And money flows into these cycles over very long periods of time ? it's a Grand Canyon effect, not an immediate rainstorm ? and in our judgment, policy has very little to do with the impact on prices in commodities over the long cycle.
HAI: Do you see this more as a secular rise that's going to continue now?
Scotty George: Keep in mind that these long cycles, these parabolas that we're describing, take generations to unfold. So they may look as if they're moving at a tectonic pace, but they're moving at their own rhythm over the long cycles.
I do believe there to be an interruption within these tectonic cycles, and that is the emergence of technology. You and I have been around long enough to know that every generation is punctuated by some type of a new development, an emergence of new innovation and technology, whether it be aircraft in the '40s, or television and radio in the '50s, the dot-com era in the '70s, '80s and '90s. Those events tend to withdraw money from the cycles and create what we call front-end, intermediate or back-end leadership.
When the front end of the market is moving, based upon innovation, you're not going to see any movement in the natural resources. When that money expires, that's when money goes more defensive and moves into these more long-term demographic themes.
HAI: So for an investor today, if you've got a long-term perspective, what's the place to put money in your opinion?
Scotty George: Particularly in agriculture. As I said, we're going to talk about the topics and break it down on a more minute basis. But no question about it. I would be careful about adding money to the short cycle today because you're looking at a lower probability of advance than, let's say, during the summer of this year. But over the long term, absolutely, we're overweighted in the tangible assets.
Why agriculture? I think when looking at the sectors as being leading, lagging or coincidental to the market, we try to measure ? through these quantitative statistics that I employ ? the velocity of probability within the capital gains spectrum. Given that, we're seeing enormous demographic leadership in the agriculture sector. And that would include potable water, as well as traditional meats, grains and other.
I believe that we're running out of fertile land. And as the population grows ? including issues that are fiscal and monetary, related to the rich and the poor ? the disparity is growing; the need for these data is becoming greater. So we're finding more and more probability of capital gains in the agriculture sector within the tangible asset group as a whole.
HAI: But historically we've crop yields going up to levels that nobody ever would have predicted. Again, that comes with technology, science, innovation, new ways of approaching farming...You don't see this as a force once again?
Scotty George: If you recall back to the dot-com era in the mid- to late-'90s, do you think anyone was interested in buying stocks like General Mills, Heinz, Hormel and what we traditionally call the consumer noncyclicals, the brand names? I don't want to imply in my response that these long-term factors aren't influenced either by short-term events or by the duration of their own cycle. But clearly, as an investor, as a portfolio manager, we have to find areas where the money is flowing currently in order to best take advantage of our asset allocation probabilities.
So, I guess the best answer I can give you is that I think these are long-term trends that have a basis in fundamentals, technical considerations, quantifiable considerations, but which are affected more so in the short run by where money is flowing and where opportunity exists.
HAI: You put agriculture as your first choice, but many people would have said oil, energy, because of the Peak Oil idea.
Scotty George: Broaden the category to basic materials. I think if you look at the market in the 11 traditional S&P sectors, or the eight which we measure, you're going to call them basic materials, tangible assets, depleting natural resources. There's no question that we have exposure, currently, to energy in both coal and traditional fossil fuels. But how long can those trends run, in the short run, before money, even within the sector, begins to look at other ideas?
So I would say gold, for example, within the basic materials, is a long-term theme that we feel quite favorable about, but which, in the short run, has run extremely long in the tooth, and from which we're taking some capital gains.
HAI: That obviously plays into your short-term outlook, now that you're seeing a lot of investment in gold, perhaps from otherwise not very sophisticated investors?
Scotty George: The latecomers, yes. I mean, I don't want to bore you with minutiae of quantifiable statistics, but in these market cycles, gold has already had three long-term investment cycles. Each of those cycles has had anywhere from three to six months running within a shorter-term duration. So gold is very long in the tooth. What I like to do is find opportunity before it occurs, or at which it reaches an inflection point of opportunity, and be a little bit early to it.
So you're correct. We've been early in these themes, just as we were early to get out of the dot-com bubble. And again, when you begin to broaden the aperture of your discovery, you notice that what we do with these measurements is to try and quantify where risk exists, and quantify where opportunity exists, be early with the opportunity and be early getting out of the risk.
HAI: Is there an area right now that you're looking at, that says, "This could be the next big thing 10 years from now"...?
Scotty George: Well, that's tough because these statistics, as you know, are backward-looking. They don't tell you specifically where the market might go. What they tell you is where the opportunity has been exhausted and where money may flow in the back trend.
So I'll put on my soothsayer hat and say to you that, obviously, alternative energy sources are going to be probably one of the key industrial sources and technology sources of new business and capital gains in our portfolios in the next decade, the names of which I couldn't even tell you, because they may not even exist yet.
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