Legendary investor Jeremy Grantham on why you should worry more about oil wells running dry and growing resource scarcity
There’s no satisfactory honest answer as to why I became an environmentalist. It’s the most important issue of our generation, so a better question is how the hell did it take me so long to get fully involved?
I have no idea why I was so slow on the uptake, which is one of the reasons I admire the early movers — Jim Hansen, Bill McKibben, Prince Charles and other people. It’s a great testimony to their instinct: they moved into top gear twenty years before I did.
It was the data in particular which drove me to the problem of resource shortage, and the awareness of how badly economists had treated the topic. Basically, they developed a perpetual-motion machine into which you put capital and labour and somehow it runs on air for ever. That’s not how the environment works.
I started as a complete believer in mean reversion — everything goes back to normal; it’s at the heart of value investing. I once thought oil, which had gone from over $100 in 1979 (adjusted for inflation) to $16 in 1999, was one of these investment bubbles.
Now, the cost of finding a reasonable amount of new oil is held to be $75 or $80, and if you’ve got to make a profit you should expect to find oil tucking in around $100 and staying there. When you think what a weak global economy there has been, it is remarkable that indeed the price of oil has stayed approximately at $100.
Then I began to have some mental twitches on the topic of oil. Why has oil stayed at $100 since 2008? There was no World War III, there was no fight with Saudi Arabia. It was really an amazing story because oil had quadrupled without any fuss, without any real screaming about it. It took me, I’m ashamed to say, two years to realise that the oil was probably not an example of the bubble breaking back to the pre-existing trend. It was the first paradigm shift I had ever come across.
Being slow on the uptake, it took me at least another two years to gestate the idea. As we studied the data, we realised that the world had begun to change pretty dramatically around 2000, and in April 2011 we came out with a report which was my one and only scoop in my life, that said we were clearly entering a new era of rising prices for resources.
That took me into the shortage and then we were compelled to ask, What are the most important resources? And the most important seemed to me to be those that affected food. For example, there is no substitute for phosphorus or potassium in the production of food, and in order to get around their finite supply we need to change to sustainable farming. We may have 50 to 60 years to do it, but such is the inertia in our farming system, you will need every minute of 50 or 60 years to get that job done. And as we’ve seen, for example in Egypt, when the price of grain goes through the roof and the population goes through the roof, it destabilises society.
How to outperform
So how can investors adapt to and aid a world of scant resources? For anyone who has a decent time horizon — ten, twenty years — the careful purchasing of forestry lands and farmland combined with the determination to improve the sustainability of the farms that they buy, even if they do it gracefully, gradually, will almost guarantee to outperform the balance of their portfolio on a long-horizon basis.
The world is simply getting squeezed by the combination of population growth, which tripled in my lifetime, and the incredible growth rate of some developing countries, notably China and India. Under that impact, it seems to have buckled the system around 2000. Even if China slows to a pathetic 5 per cent growth, fourteen years from now it doubles its coal demand and the world will have to find another 48 per cent of total global coal production for China alone. These things do not compute. Any reasonable mathematician knows you cannot have compound growth in a finite world.
When you’re confronted with China and scarcity, what do you do as a long-term investor? Land is the key ingredient, food the most important long-term shortage, then you move down to metals. We’ve studied the data pretty hard and it’s clear that you outperform if the metals gain in real terms, and I think there’s little chance that they will not, in the long run, show a rising trend.
A secondary reason why you’ll outperform is that the volatility of commodities intimidates investors, including value investors. We’ve got a list of a dozen important value investors and we’ve found that over ten years, their ownership of commodities was a fifth of the market weight. Why? Because there’s nothing a value manager hates more than the kind of colossal uncertainty of a couple of years’ price change in the underlying resource will give you. They know that and they hate it, so they avoid them. The whole market feels the same way, so mining stocks are on average very cheap.
You shouldn’t underestimate renewables either. The progress in renewables is so much faster than the typical, reasonably well-informed businessman realises. With the price of solar panels having dropped to a quarter in the past three years, they’re on the cusp of changing the whole utility business.
So my suggested portfolio already two years ago was that 30 per cent should be in resources, with 15 per cent in forestry and farmland, 10 per cent in high-quality stuff in the ground and the remaining 5 per cent in resource efficiency plays.
The last is a tough way to make a living because we all know how easy it is to lose money in enterprising new ideas — but it is where the growth will be.
FOREVER BURSTING BUBBLES
As a bubble specialist, we owe Alan Greenspan and Ben Bernanke a lot because of the exceptional monetary situation of the past twelve years. But for them we would not have anything like the tech bubble in the US or the global bubble of 2007 or the great bubble I see in 2016/17.
If you have artificially low rates, you have a slow but remorseless pressure putting asset prices up, because people month by month throw in the towel on their willingness to invest in negative return cash and short-term bonds and so on. It doesn’t feel like a bubble yet, but it surely will be before Bernanke finishes.
I compare it to the donkey and the racehorse: Bernanke really believes that the US should be growing at 3 per cent, and that can’t happen with workforce growth of 0.2 per without a surge in productivity.
Bernanke is trying to keep his foot down until we grow at 3 per cent, so he thinks he’s got a racehorse but he’s actually got a donkey. He’s going to keep whipping it until the donkey turns into a racehorse or keels over and drops dead. A betting man takes the dropping dead.