Grantham predicts commodity crash on scale of financial collapse

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GMO’s self confessed perma-bear Jeremy Grantham has rung the alarm bell on rising commodity prices predicting a crash ‘not unlike the financial collapse’.

In his latest quarterly letter titled Time to wake up: days of abundant resources and falling prices are over forever’, he argues that a combination of better than expected weather and a blip in China's 'warp speed' growth due to anything from wage increases, misappropriated capital in large, unnecessary projects, rising debt or a house price bubble, could drag commodity prices down dramatically.

He warned: ‘If the weather and China syndromes strike together, it will surely produce the second “once in a lifetime” event in three years.’ 

Elaborating, he said: 'Several of my smart colleagues agree with Jim Chanos that China’s structural imbalances will cause at least one wheel to come off of their economy within the next 12 months. This is painful when travelling at warp speed – 10% a year in GDP growth.'

'The significance here is that given China’s overwhelming influence on so many commodities, especially in terms of the percentage China represents of new growth in global demand, any general economic stutter in China can mean very big declines in some of their prices.' 

'You can assess on your own the probabilities of a stumble in the next year or so. At the least, I would put it at 1 in 4, while some of my colleagues think the odds are much higher.' 

'If China stumbles or if the weather is better than expected, a probability I would put at, say, 80%, then commodity prices will decline a lot. But if both events occur together, it will very probably break the commodity markets en masse. Not unlike the financial collapse.'

Alluding to his reputation for getting such big calls right, he said: ‘Modesty should prevent me from quoting from my own July 2008 Quarterly Letter, which covered the first crash'. In that note he wrote: 'The prices of commodities are likely to crack short term but this will be just a tease. In the next decade, the prices of all raw materials will be priced as just what they are, irreplaceable.'

Now he says that point has been reached and that ‘Mrs. Market is sending us the Mother of all price signals.’

‘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 II.’

‘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.’

He says that after the financial crisis of '08, institutional investors were too preoccupied with staying afloat to have obsessed much about the first opportunity in commodities as everything else was also down in price. But he thinks that was a 'once in a lifetime' investment opportunity as 'most markets crashed by over 50%, some much more, and then roared back.' 

Grantham however believes investors will be presented with another such opportunity in the coming years,

'A second commodity collapse in the next few years may also be psychologically hard to invest in for it will surely bring out the usual bullish argument: “There you are, its business as usual.  There are plenty of raw materials, so don’t listen to the doomsayers.”  Because it will have broad backing, this argument will be hard to resist, but should be,’ he said.