We have been talking about the problems in China, weaker commodity prices, problems with oil economies, and volatile currencies affecting the markets globally. There are just too many variables.
Given what is happening globally it seems there is going to be disruption in the investment world and patterns of investing where well-established historical correlations are likely to be challenged in a meaningful way.
It is evident that weakness in China and anaemic global growth are leading to weakness in commodity prices (both base metals and oil). However, it is more important to assess whether the current weakened prices are the new normal and if yes then what can be the likely subsequent changes and thereby the effects on the global economy and investments.
I believe the weakened commodity prices are here to stay. While slower economic growth in China and the weaker yuan will keep base metal prices in check and, as a corollary, deflate exports, oil and fossil fuels are in for a structural weakness till either excess capacities get used or are shut down.
The massive focus on renewables and clean energy (solar, wind, biomass, nuclear) globally along with the commitments on Conference of the Parties 21 climate summit and weakened global growth, along with increased supply from Iran, may sound the death knell for a longer period for oil and other fossil fuels.
Commercially, until now, there has always been a trade-off between oil prices and the commitment for renewables. However, increasingly, heightened public realisation of the ill effects of climate change cannot be ignored.
Having said that, there can always be shorter-term spikes in oil prices but longer-term trend is likely to be weak. This is extremely important, and it has the ability to disrupt well-laid investment patterns.
Among the major contributors to longer-term capital and investments were the sovereign wealth funds (SWF). The top seven of these funds are either of oil-centric or other commodity-centric economies. Estimates are that these top seven SWFs have about $5 trillion of assets under management. Given the turmoil these economies face, leave aside fresh investments, markets globally may see redemption across asset classes (this is already playing out) from them to service their own need for capital in their respective economies.
The direct impact of this is likely to be seen in the capex cuts by upstream companies globally, which is estimated to be around $225 billion and the capex and public expenditure cuts by the oil-producing countries because of their deteriorating fiscal situation.
Traditionally, we have associated GDP growth to early-cycle movers like industrials. Looking at the likely massive capex cuts in oil-producing countries and focus on efficiency and productivity globally, we will see pressures on global industrials, as capacity utilisation grinds lower and China’s economy slows.
The debt-related stress on upstream oil companies is also evident. It is also reflected in weak industrial production numbers globally. While oil and gas, industrials and commodities were large contributors to global growth till now, going forward, and we in the transition phase already, the emergence of disruptive technologies and business models will take advantage of long-standing inefficiencies in the systems to provide much-needed growth.
So what does all this mean? I think we are in for disruption in the investment world where we are seeing longer-term shift of wealth from oil and commodities producing surplus countries to consuming countries. It would be a while before the beneficiary countries start spending as they will try to get their house in order first and repair their balance sheets.
In the meantime, a massive shakeout can happen as liquidity tightens across the global economy. The regular stimulus by various global economies will be prone to the effect of diminishing marginal utility, and thus will not be able to pump up asset prices in a deflationary environment.
I am not even going on the path of geopolitical effects, which can be dangerous, as a result of this. It’s a structural shift from the so-called old economy to the new economy. Companies and economies that focus on efficiency leading to productivity gains would be able to see through this turbulent phase.
However, it’s not a doomsday scenario. The pockets which are likely to lead future growth are disruptive technologies and business models with technological focus. Startups with innovative ideas are likely to be sought after. We are in a transit mode and we may see huge realignment of our preferences for investments. Disruption is coming!
Vaibhav Sanghavi is managing director at Ambit Investment Advisors Pvt Ltd.
