Jordan Opportunity manager Jerry Jordan says the world will be massively supply-challenged as commodity production fails to keep up with a reaccelerating global economy.
Ryan Leggio: I know that commodities is one of your two large secular themes you're working with right now. Can you talk a little bit about how you arrived at that theme and really what you mean by commodities being a secular theme?
Jerry Jordan: Sure. I think like a lot of folks, we became enamored of the idea back in 2001-2002--we were bullish in energy actually as early as '98, but commodities in aggregate in that 2002-2003 period--with the idea that the emerging markets were really emerging, and we were slowly and inevitably using up all that excess supply.
So if you take something like oil, take something like copper, we have had this growing demand out of China as they've built up, but we've also gotten it out of India, and Russia, and the Middle East. A lot of people don't talk about it. The Middle East's use of natural gas, for instance, is up tenfold in the last 10 years.
So a lot of these countries that produce raw materials are actually using a lot of raw materials in their attempt to produce more raw materials, so it's somewhat of a vicious cycle.
But we continue to be supply-constrained because either not enough money was spent a decade ago to find new copper deposits, or the countries that have the copper deposits or oil deposits aren't all that happy about other people taking them from them, so they're raising the royalty rates, or just causing trouble. We know in West Africa it's getting harder and harder to get oil offshore because of all of the rebels that are causing trouble.
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And with each one of these cycles that we get, when the commodities drop, everybody steps back and they say, "Whoa, commodity prices are too low, let's cancel all our cap-ex spending programs." And then it takes another year or two for these cap-ex spending programs to actually start to get formalized again.
This most recent decline is going to be a killer, because folks that watched oil, for example, go from $140 to $35, what's the price for oil where people are going to feel confident about really bringing on these projects again? Brazil is going to do it because they've said they're going to do it. There's a lot of other projects that people have just taken off the drawing board that were originally maybe going to come on in 2014, 2015--they're now gone.
So, does oil have to be $100? $120? If it's $120, how long does it have to be at $120 before people are willing to really put on a big project? And that's the dilemma. We still to this day have never produced more oil than we produced in the summer of 2006. Even when oil went from $60 to $145, there was no increase in oil production globally.
So the question is, now how hard is it going to be to produce oil going forward? So this is a perfect example of where we think we are massively supply-challenged, and so you're really going to have to adjust demand to keep prices reasonable.
China is selling cars like crazy; India is starting to sell cars like crazy. Our car selling may slow down, but, honestly, it has to. The only way we're going to balance the oil market, as an example, is to sell fewer cars here so that they can sell more cars, because they've got a lot of people that don't have cars.
Leggio: Sure, and one of your largest holdings is actually not a company at all, it's the PowerShares Commodity ETF, which I believe owns a basket of four commodities. How did you choose that particular investment vehicle, and how do you go about valuing a particular basket of commodities?
Jordan: Sure. So it's the Deutsche Bank Agriculture ETF, DBA is the symbol. It's a quarter sugar, corn, soybeans, and wheat. Sugar is essentially an energy play because it's sort of an ethanol proxy, and then the other ones are grains. And the reason we got attracted to it was grain prices are down a lot in the United States, globally, but they're being driven by strong production out of the Midwest in the grains.
Sugar prices just made a 25- or 30-year high. So sugar prices are exploding, but the grain prices are being held down because of U.S. production.
The thing about it is, production overseas for grains has been atrocious. There's been a monsoon season, India has been awful, so rice production is a disaster. I think that's going to really draw down wheat stocks as we get deeper into the winter this year.
At the same time, China has had drought problems, New Zealand has had drought problems, Argentina has had a disastrous drought, and production is way off. So we've got a situation where inventories of grains weren't all that high coming into this, and this increase in U.S. production is really, I don't think, going to do much other than sort of balance off the weakness elsewhere.
So we're going to come out of this year heading into next growing season without much of a change in inventories, which are too low, a global economy that's reaccelerating, and fertilizer and nitrogen usage which is down 50%, which means that yields are bound to be lower next summer, and unless they start really laying down the fertilizer, they're going to be even lower in 2011.
So we think this is--unfortunately it's been sort of a drag in the portfolio because we've owned it for six months and it's basically gone nowhere in a market that's up 50%, but we think its time is coming.
