Visualizing History
Capital Flow Booms, Double Busts, and New Sovereign Defaults (1815 – 2015)
From the Archives
The Cycles of Speculation (1907)
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Sunday Reads
Stocks and bonds are usually the topics du jour, but commodities have recently been enjoying their day in the sun. Bloomberg reported this week:
“The prices of raw materials used to make almost everything are skyrocketing, and the upward trajectory looks set to continue as the world economy roars back to life.
From steel and copper to corn and lumber, commodities started 2021 with a bang, surging to levels not seen for years. The rally threatens to raise the cost of goods from the lunchtime sandwich to gleaming skyscrapers. It’s also lit the fuse on the massive reflation trade that’s gripped markets this year and pushed up inflation expectations. With the U.S. economy pumped up on fiscal stimulus, and Europe’s economy starting to reopen as its vaccination rollout gets into gear, there’s little reason to expect a change in direction.“
Copper
From a historical perspective, the significant rally in Copper prices has been particularly interesting. As Bloomberg writes, the rally in recent years has been driven by global government’s commitments to increase renewable energy sources and electric vehicle usage. Copper will play a large role in these developments, as in 2020 alone roughly “1.9 million tons of copper was used to build electricity networks.”
There are two interesting historical precedents related to this story. First, the boom in prices of commodities tied to an automobile “revolution” is reminiscent of the Rubber boom of 1910. In that period there was a dramatic rise in Rubber prices on the backs of increased automobile production and the launch of Henry Ford’s Model T in 1908. The automobile, coupled with a Bicycle boom just a decade earlier, meant that there was a huge demand for rubbers to manufacture tires. This is clearly demonstrated in the graph below:
The investing public’s response was to launch an early version of “sector funds” dedicated to solely investing in Rubber plantations and the commodity itself. Speaking to the boom in rubber prices resulting from automobiles, a portfolio manager at the rubber Plantation Investment Trust commented:
“If you take two of the industries which are practically the largest users of rubber, like electricity and motor traction, I do not think that anyone can come to any other conclusion than that both these industries, large as they may be to-day, as yet are only in their infancy.”
In 1910, The Economist reported that there was a “city merchant who abandoned his own business at the beginning of the year in order to devote his whole time to dealing in rubber and in rubber shares, with results, up to the present, satisfactory.”
Even more remarkable, the same article stated:
“A little syndicate was formed last month by a few guests staying at a hotel in one Swiss winter sport resorts. It has acted with some success and is still alive, though to our mind, a man who operates in the rubber market when he might be out skiing deserved to be repatriated.”
While you can read more about this Rubber Boom in one of today’s linked articles, I mention this story because there is a clear parallel to the explosion in commodity prices for components that are key to electric vehicles and other green initiatives. Whether this be Copper, Lithium, etc., it all feels familiar.
The second historical precedent for booming Copper prices traces back to the San Francisco Earthquake of 1906, and ensuing Panic of 1907. The first paper in today’s Sunday Reads dives into this further, but just like prices for the commodity are rising today in relation to the increased demand for new electrical grids / networks, etc., there was a similar phenomenon in 1906 as the city of San Francisco had to be rebuilt:
“By the first decade of the twentieth century, approximately half of the primary copper consumption in the US was claimed by the electrical industry. Indeed, the electrical grid was being built at a rapid pace at the turn of the century… Not only was wire demanded for the burgeoning telecommunications industry as telephone usage expanded, but it was also the backbone for constructing the lighting infrastructure and the electrification of transportation such as the urban subways and railways. The miles of rail track operated by electricity increased from 21,907 in 1902 to 34,059 by 1907…
Consistent with our conjecture that copper consumption increased as a result of the rebuilding of San Francisco after the earthquake on April 18, 1906, the U.S. Geological Survey reports the consumption of copper was at 318,000 tons up 19.5% in 1906 as compared to 1905, the largest increase since 1902. U.S. production was up 14.8% in 1906 compared to 1905 and global production was up only 1.5%…”
Like today, prices rose in tandem:
As the author’s of the paper below explore further, however, there is an argument that the declining prices in 1907 (see graph) led to a global crisis in 1907 as banks failed due to borrower’s heavily leveraged to copper prices went bust. This is not to say that something similar will happen today, but the parallels for booming copper prices related to the intense building of electrical grids / networks is fascinating.
Now, let’s dive in!
Copper & The Panic of 1907
Aftermath of The 1906 San Francisco Earthquake
Why This is Relevant:
Just like prices for the commodity are rising today in relation to the increased demand for new electrical grids / networks, etc., there was a similar phenomenon in 1906 as the city of San Francisco had to be rebuilt.
“Was the New York Panic of 1907 only one phase of a worldwide phenomenon? We test the hypothesis of Alexander D. Noyes, who was a contemporary financial market observer of the period, that banking crises in Egypt, Japan, Germany, Chile, Holland, Italy, and Denmark were related to severe drops in commodity prices. Using commodity prices, interest rates and timelines, our results indicate that changes in the Bank of England’s discount rate had a unidirectional causal relationship to copper prices.
Gold outflows from London, meant to be reversed by rate hikes, may have been fueling a rise in copper prices. We find that the event of gold arrivals in San Francisco in September 1906 to settle earthquake claims may have had a positive relationship with copper prices. Inelasticity in both quantities supplied and demanded for copper with respect to price likely contributed to volatile copper price behavior. Bank failures in New York, Japan, Germany, Italy, and Chile share in common a bank failure related to a borrower leveraged to copper. We find support for Noyes’ hypothesis that the causes of the crisis may have been global rather than domestic.”
Visualizing History:
Notable Quote:
“Between the mid-1870’s and the late-1930’s there was approximately a ten-fold increase in world per capita primary copper consumption… the U.S. emerged as the world’s largest single copper consumer and producer between 1876 and 1920…
By the first decade of the twentieth century, approximately half of the primary copper consumption in the US was claimed by the electrical industry. Indeed, the electrical grid was being built at a rapid pace at the turn of the century… Not only was wire demanded for the burgeoning telecommunications industry as telephone usage expanded, but it was also the backbone for constructing the lighting infrastructure and the electrification of transportation such as the urban subways and railways. The miles of rail track operated by electricity increased from 21,907 in 1902 to 34,059 by 1907…
Consistent with our conjecture that copper consumption increased as a result of the rebuilding of San Francisco after the earthquake on April 18, 1906, the U.S. Geological Survey reports the consumption of copper was at 318,000 tons up 19.5% in 1906 as compared to 1905, the largest increase since 1902. U.S. production was up 14.8% in 1906 compared to 1905 and global production was up only 1.5%…”
The 1910 Rubber Boom & Momentum Investing
“A Boom Against Many May Be Wrecked: The Remarkable Dealings in Rubber Shares”
Prices for commodities related to the green revolution have exploded in the last 12 months, with copper being the prime example. I wrote this paper about how a similar scenario played out in the early 1900s as rubber prices soared on the backs of increased demand from automobile manufacturers (who needed rubber for tires).
The ‘Rubber Boom’ in early 20th century London offers a perfect case study of how strong stock returns originally justified by growing earnings can quickly morph into a speculative ‘boom’. Investors chased returns, herded into rubber companies’ shares, and ignored information that indicated a reversal was likely.
First, it is important to understand what drove the excitement for rubber shares. As it turns out, the reasoning was simple. Coming off the back of a ‘bicycle mania’ at the end of the 19th century, another new technological innovation requiring tires had just started rolling off the assembly lines in America: the automobile. Explaining his investment thesis, one investment manager exclaimed:
“If you take two of the industries which are practically the largest users of rubber, like electricity and motor traction, I do not think that anyone can come to any other conclusion than that both these industries, large as they may be to-day, as yet are only in their infancy.”
These two new forms of transportation, particularly the automobile, led to a burgeoning demand for tires, and consequently, rubber.
“The Rubber Boom undoubtedly has solid foundation. New uses are constantly being found for rubber, and there is an increasing demand for the articles in which it is used to present…. There are ample materials here for a legitimate boom, and there can be little doubt that there are good prospects of a prosperous future for those rubber companies which have chosen their ground well, and whose flotation has been carried with wisdom and moderation.”
Visualizing History:
Rubber Plantation Investment Trust Shareholder Meeting (1910):
“What a change do we find in the conditions of the rubber share market since I had the pleasure of addressing you in June last… Now everybody has a craving for rubber shares. One of the first paragraphs in the summary of every financial paper is devoted to the rubber market and a breakfast table unadorned by at least one rubber prospectus would look very unappetizing…
Your board have not omitted to take advantage of this state of things, and they have, of course, had many opportunities of furthering your interests by acquiring blocks of shares in the best rubber companies… The public subscribed all these securities with great avidity, and they have attained to substantial premia.”
Global Cycles: Capital Flows, Commodities, and Sovereign Defaults, 1815-2015
Why This is Relevant:
There has recently been a lot of focus on rising commodity prices, inflation, capital flows, and how they all relate. Well, this paper aims to provide the long historical context for these very questions.
“Capital flow and commodity cycles have long been connected with economic crises. Sparse historical data, however, has made it difficult to connect their timing. We date turning points in global capital flows and commodity prices across two centuries and provide estimates from alternative data sources. We then document a strong overlap between the ebb and flow of financial capital, the commodity price super-cycle, and sovereign defaults since 1815. The results have implications for today, as many emerging markets are facing a double bust in capital inflows and commodity prices, making them vulnerable to crises.”
Visualizing History:
Notable Quote:
“International capital flow cycles have displayed similar patterns over the past 200 years, both in duration and amplitude. While not all capital inflow cycles ended with a global wave of new debt crises, all the major spikes in sovereign defaults came in the heels of surges in capital inflows, especially those followed by ‘double busts’ in capital and commodity markets.”
Commodity and Manufactures Prices in the Long Run
“Illustration shows a man representing big business exhorting two men labeled “Trusts” to test their strength by hitting a peg shaped like a man labeled “Consumer” with a large mallet labeled “Tariff”; Joseph G. Cannon is standing to the left, pointing a baton at the consumer, showing the man with the mallet where to strike. The top of the tower, where the bell hangs, is labeled “Profits”. The U.S. Capitol is just beyond the trees, in the background.”
Why This is Relevant:
Arguably the most important aspect of rising commodity prices right now is how it relates to the “re-opening” of the global economy, inflation, and manufacturing prices. This paper dives into the relationship between Commodity and Manufacturing prices in the long, long run.
“The low level of primary commodity prices since 1985 is examined in the context of the behavior of those prices relative to prices of manufactured goods since 1854. The Prebisch-Singer hypothesis of a secular decline in relative commodity prices is sustained, but the recent decline is shown to be well outside the realm of historical experience. Commodity and manufactures prices are found to be cointegrated, conditional on the negative trend and a number of unexplained short-term swings. The earlier finding of a Gibson paradox is explained in terms of the difference between short- and long-run relationships.”
Visualizing History:
Notable Quote:
“Although there is a deterministic secular trend, whereby the relative price of primary commodities has declined by around 1/3 of 1 percent per annum, the relative price is otherwise stationary. There is a strong and significant tendency for it to revert to its trend-adjusted mean level. Output growth in industrial countries tends to lower the price of manufactures relative to those of primary commodities, while increases in monetary growth rates or in nominal interest rates tend to raise the price of manufactures relative to commodities.”
Commodities for the Long Run
Why This is Relevant:
When prices boom in any asset class, it tends to pique the interest of investors and speculators alike. This paper studies the long history of commodity prices, and what returns for an index of commodities offered since 1877, and what the lessons are for market participants today.
“This paper analyzes a novel data set of commodity futures prices over a long sample period starting in 1877, which allows us to shed new light on several important and controversial questions. We document that commodity futures returns (1) have been positive on average; (2) vary significantly across business cycles, inflation episodes, and periods of backwardation versus contango, (3) are driven mostly by variation of spot returns and therefore closely linked to the underlying commodity spot market; (4) perform well during inflation cycles and provide more return in backwardated states; and (5) display low correlation with stocks and bonds. These long run stylized facts imply that commodity futures can add value to a diversified portfolio from an asset allocation perspective.”
Visualizing History:
Notable Quote:
“Commodity futures index returns have been positive and significant since 1877. While the performance has come both from the excess spot portion of returns as well as the interest rate adjusted carry portion of returns (i.e., roll yield plus short rate or the convenience yield), the carry component has earned the lion’s share.”
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