Denver Investment Manager

Prior to the final week of June, the Dow had declined in seven of its previous eight weekly sessions. U.S. manufacturing expanded briskly in June and this is one of the most widely accepted indicators on the health of the economy. This report greatly exceeded expectations and is largely credited for the market's strong bounce.

In the months prior, investor sentiment was sour due to a laundry list of disappointing economic numbers. The chaotic European debt crisis, the end of the Federal Reserve's bond buying program (widely referred to as QE2), still high levels of unemployment and the political stalemate over raising the government's debt ceiling were all contributing factors. The problems are numerous and complicated and we continue to try to be careful, nimble and opportunistic. Treasury note had one of its steepest weekly declines in two years in late June with the yield rising by 0.33 percentage points. As the indices show, stocks have outperformed bonds year-to-date.

Last April, Jeremy Grantham published a very detailed report forecasting a global economy threatened by diminishing natural resources and per capita affluence.(1) "The world is using up its natural resources at an alarming rate, and this has caused a permanent shift in their value," he wrote. This coupled with a rapidly growing global population has likely permanently reversed a nearly century's long decline in commodity prices as the following table illustrates. (The index is comprised of an equally weighted basket of 33 agricultural and industrial commodities.)

(1) Jeremy Grantham - "One of the Greatest Inflection Points in Economic History"

Commodity prices declined at a 1.2% annual rate over the past century as the marginal cost of production was outstripped by gains in productivity. However, over the past eight years the price declines witnessed over the previous century have reversed as the commodity sources with the lowest marginal costs have already been used up or exploited. For example, the rate of oil production peaked in the United States in the 1970's and now it appears to be peaking globally as well. As a result, the marginal cost of production is rising and this is reflected in the price of oil.

Copper and iron ore are exhibiting some peak characteristics and some agricultural commodities as well. A great deal of the increases in crop production has been the result of increases in the use of fertilizers. Fertilizer is similarly constrained by diminishing resource inputs such as potash and phosphates. Anyone that grocery shops on a regular basis knows that these higher costs are being passed on to the consumer. Because income growth has been largely stagnant over the past decade, a greater share of income is being devoted to food and fuel leaving less for discretionary spending. This acts as a drag on economic growth and it also has a hugely disproportionate effect on lower wage workers and developing economies.

The primary driver of this paradigm shift is emerging market demand, particularly from China. High levels of capital spending there are upsetting the delicate balance of global supply and demand. China consumes 47% of all of the world's coal, 53% of the cement, 45% of the steel and 39% of the copper. With rising incomes and standards of living we will see additional pressure on the prices of agricultural commodities as well.