Things tend to run in cycles. Winter turns to summer turns to winter. Day gives way to night gives way to day.
Stock markets have boom years, and years when they fall. Recently, Kerry Balenthiran identified a 17-year stock market cycle.
Commodities also have cycles. The twentieth century has seen three commodity booms: 1906-1923, 1933-1953 and 1968-1982. Interestingly, these commodity supercycles have alternated with stock market booms, like a sort of investing yin and yang.
A cycle based on supply and demand
Investment guru Jim Rogers has talked about rising commodity prices increasing input costs and reducing company profits, thus causing stock markets to fall. Conversely, falling commodity prices reduce input costs and boost profits, leading to rising stock markets. At the heart of this is the basic economic principle of supply and demand.
Most recently, from the late 1990s to the eurozone crisis of 2011, we have seen another commodity supercycle, with prices of minerals and metals rocketing, as emerging markets, particularly China, have had a building and infrastructure boom.
But just in the past few years we have seen commodity prices falling, and the shares of many mining companies have been falling with them. The share prices of companies such as Kazakhmys and Vedenta have been absolutely trashed.
The supercycle model is interesting and has a lot of merit, but I think it is a touch too simplistic. People talk about the end of China’s building and infrastructure boom. But China is still growing rapidly, and other emerging and frontier markets are now surging ahead. I think this will put a floor on commodities demand.
A more subtle picture
Overall, I think the picture is more subtle than the broad-brush picture of the supercycle. In terms of the more volatile, speculative minerals and metals — for example, copper — there has definitely been a dramatic rise and then fall in commodity prices. This is why copper producer Kazahkmys has seen its share price tumble.
But if we take Rio Tinto (LSE: RIO) (NYSE: RIO.US), this is a bigger and much more stable company. It makes the bulk of its profits through iron ore, the price of which is far less volatile than metals such as copper.
Whenever I am unsure about a company, I analyse the numbers. We see that Rio Tinto is on a 2014 P/E ratio of 9, falling to 8 in 2015. The dividend yield is 3.5%. This looks cheap. There is the proviso that there is unlikely to be a surge in profits, and I suspect the iron ore price will edge downwards.
But then Rio Tinto is already a giant with a £50 billion market capitalisation, so you wouldn’t expect rapid growth. However, I see the business as a solid blue-chip company that is still highly profitable, with a juicy dividend to boot. Thus it is worthwhile investing in as part of your high-yield portfolio.