How different things are today, notes Jackson. Most commodities, gold among them, have been racing away again. But in judging such things, we no longer rely on a couple of weird sisters in Costa Rica. We go by logic and fundamentals.Well, sort of. There are several possible reasons for a rising gold price, such as a reluctance by rich individuals to entrust cash to today’s banking system. But the most popular reason – fear of inflation – seems less than logical.
We would expect fear of inflation to show up elsewhere, most obviously in the yield gap between inflation-linked Treasury bonds (TIPS) and conventional Treasuries. For if we take the yield on TIPS to be real, the gap represents inflationary expectations.
Since the start of this year, the gold price has risen 15 per cent, while the TIPS spread has not risen at all.
Since the start of last year gold is up some 40 per cent, and the TIPS spread has actually fallen.
In any case, who said gold was an inflation hedge? The price today is about $730 per ounce. When the Aden sisters were on the case it hit $875. Adjusted for US inflation, the price has fallen 60 per cent.
To Jackson, this seems symptomatic:
At a Commodities Week conference in London last week, I heard various fund managers talking up commodities as an asset class. Most of their logic seemed pretty flaky as well.
Much was made of the lack of correlation between commodities and other assets. It was worth accepting a lower return on commodities than on fixed interest, we were told, because they behaved differently from bonds and equities.
That was why pension funds started moving into them five years ago.
But the single biggest headache for pension funds five years ago, recalls Jackson, was that bonds and equities were behaving differently from each other. As they parted company, so liabilities rose and assets fell.
Diversification, in other words, “means different things at different times,” he notes.
That apart, the conference was a handy reminder of how far the commodities bull story relies on guesswork. In particular, “we were told that even if the US economy succumbs to its housing crisis, the rest of the world – for which, read China – will be unaffected”.
There is simply no means of knowing that, since we are in new economic territory.
Nor do we know whether the recent strength in commodity prices is structural or cyclical. But a word of warning came from David Humphreys, who as chief economist first with Rio Tinto and now with the nickel giant Norilsk has seen more cycles than most.
The base metals industry is crucially exposed to time-lags, he noted. Both supply and demand are inelastic and lead times are long. In the last cycle, the copper price peaked in 1995. But capital expenditure kept rising until 1997 and production did not peak until 2003.
This time, the cycle could prove more acute. In the 1990s, the psychology of the big mining companies was dominated by low growth expectations. When the present cycle kicked off in 2003, they were slow to grasp how things had changed.
When they did, they ran into the usual supply constraints caused by rising prices, only worse.
But there are now enormous projects under way. For the next three or four years at least, big increases in the supply of base metals are inevitable.
Meanwhile China forges ahead on the basis of cheap labour, free capital and – until lately – free use of the environment. It also consumes about three times as much base metals per unit of GDP as an advanced economy – for the meantime, anyway.
Could that all go wrong? “Search me,” says Jackson. But, he adds, “while it is easy to poke fun at the Aden sisters, it is slightly harder to spot the difference between them and their modern-day successors.”