Commodities for Every Portfolio: Part One

As you can imagine, the industrialization of emerging economies makes up a significant portion of the increased commodity demand over the last several years. But a question that I am often asked is what happens once China and other emerging economies complete their industrialization. Does the completion of industrialization signal mark an end to the commodity bull market? I don't believe it does.

One of the transitions that will occur in the midst of this commodity boom is a shift in the primary demand for commodities. The first stage of this commodity boom is undoubtedly driven by the massive demand for raw materials, such as copper, aluminum, and oil, which are essential in the development of the economic infrastructure. This is why we have seen industrial commodities lead the way in terms of appreciation. The second stage, however, is centered on the growing wealth and spending habits of consumers who reside in most of these developing economies.

This change, of course, is quite logical. One by-product of industrialization is the creation of a wealthier and more educated working class. Therefore, greater than one-third of the world's population (the population in the world's economies) will now have more money to spend: on food, on entertainment, on goods and services that consume commodities. To illustrate this point, imagine this scenario:

"In China, a major U.S. company decides to open a manufacturing plant on the outskirts of a city. In order for their plant to run at maximum capacity, they will need to find 2,000 workers. Soon the word is out that the company is paying 20 percent more than what the local farm worker earns. The jobs are immediately filled, and 2,000 people are now making more money. Since most of these workers have no debt, they now have additional income to spend. With the additional discretionary income comes a change in lifestyle. Some of the workers might eat out more often; others might purchase more expensive food products, such as meat; still others might actually go out and purchase the washer and dryer that they have always wanted. Regardless of their expenditure, the end result is the same. Average Chinese consumers are way on the way to westernizing their lifestyles."

This type of wealth creation will occur not only in China, but also in most of the other developing economies. Citizens who typically spend money only on necessary expenditures will begin to indulge in the consumption of goods and services that are standard in most western economies. In fact, if you look at other historical examples of industrialization (that occurred in the United States and European countries), a similar type change took place.

In addition to the spending by these factory workers, there will also be a trickle-down effect as these workers now have more money to spend in the local economy. When they go out to eat, the local restaurant owners benefit. When they buy new clothes or electronic gadgets, local merchants will earn more. In short, the new wealth and spending habits of the factory workers will translate into additional wealth for the business economy. In turn, this will eventually lead to further spending, further growth, and a continued demand for commodities.

As a matter of fact, you can already see this cycle begin to play out in China. The increase in both discretionary income and spending was affirmed in a 2005 survey taken by the National Bureau of Statistics of China. According to the survey, per capita disposable income grew by 11.6 percent year over year. In other words, the average Chinese urban household had additional 11.6 percent more money to spend. Not surprisingly, per capita consumption also increased by 9.8 percent during that time period. Specifically, food expenditures increased by 6.2 percent; clothing expenditures increased by 12 percent; appliances and services expenditures rose by 10.4 percent; transportation and communication expenditures rose by 15.2 percent; and education and entertainment expenditures grew by 11.7 percent.

Indeed, the rise in consumer spending throughout the developing economies is bullish for most commodities. Hard commodities will benefit as the demand for electronics, appliances, and transportation increases. Imagine if the Chinese start trading in their bicycles for automobiles. Not only will there be a greater demand for fuel, but there will also be increased demands for aluminum, copper, platinum, palladium, zinc, and other raw materials that are necessary to build cars. The same can be said for any products that require commodities. Besides the consumer demand for commodity-based products, there will also be rising demand for agricultural commodities as food.

The above is an excerpt from Part One: Understanding the Commodity Markets. The following chapters make up this section:

Chapter 1: The Long-Term Commodity Boom: Why it's Here and Why it's Going to Last

Chapter 2: From the Farmer to You: How The Futures Markets Work

Chapter 3: Debunking Commodity Myths: Why Commodities Belong in Your Portfolio

To find out more about Commodities For Every Portfolio: How You Can Profit From the Long-Term Commodity Boom, please click here.

Emanuel Balarie

CEO, Jabez Capital Management

Editor, CommodityNewsCenter.com

ebalarie@jabezcap.com

312-466-5561

Excerpted with permission of the publisher John Wiley & Sons, Inc. from Commodities For Every Portfolio: How You Can Profit From The Long-Term Commodity Boom. Copyright (c) 2007 by Emanuel Balarie This book is available at all bookstores, online booksellers and from the Wiley web site at www.wiley.com, or call 1-800-225-5945.