Should investors chase the AI boom higher or stock up on commodities?

With mining stocks taking a nosedive in 2023, some investors may be looking to exit their positions.

However, the data I’m going to show you today, suggests we’re on the precipice of one of the largest commodity booms yet.

I know that’s hard to imagine right now. This has been a brutal year for the sector.

It’s disappointed those investors following the green energy transition and the upward pressure this is supposed to have on commodity prices.

Yet despite all the hype and a brief lithium spike in 2022, there’s nothing resembling a multi-year secular bull market.

But don’t let 2023’s sell-off dissuade you from the long-term opportunity. Heavy discounting is offering enormous value for those investors able to brace for the inevitable turnaround.

You see, right now, commodity markets are serving up a once-in-a-century value opportunity.

To show you what I mean let’s compare this market to U.S. equities by looking specifically at the world’s most important index: the S&P500.

If we were to cherry pick the post-Global Financial Crisis lows from 2009 and trace those gains into the late 2021 peak, this U.S. index returned investors a gigantic 500% plus return.

Not bad for a large-cap market index! In fact, the bull market that lasted from 2013 to 2022 was a record breaker.

That’s why we’d expect to see other countries or asset classes, including Australia, start playing catch up against a decade-long era of outperformance held by U.S. equities.

But so far, in 2023, U.S. equities continue to outperform and are approaching their all-time highs from last year.

This year’s strength has surprised many. Led by the large-cap tech sector, the S&P 500 continues to defy the odds as investors pile into AI mania.

So, will this trend of outperformance against other markets continue?

Who knows how far AI will push the US large-cap tech stocks… We can’t discount the fact that there might still be plenty of juice in the U.S.-equity tank — meaning the AI trend could bubble for some time yet.

But given the decade-long era of outperformance that’s already taken place, this is a market for speculators; not long-term value investors.

With each passing year of U.S. equity outperformance, the odds of major correction increase.

And right now, relative to U.S. equities, commodities are offering immense value.

Just take a look at the graph from Benchmark Intelligence below…

Source: Benchmark Intelligence

As you can see, the ratio between the GSCI Commodity Index against the S&P500 is hovering around decade-lows.

Not surprising when we look at the strong outperformance of U.S. equities against virtually every other asset class.

But the most important point to get is this.

Historically, when commodities are grossly undervalued against U.S. equities, like they are right now, a bull market in mining stocks ensues.

A multi-year boom across the entire periodic table of metals precipitated after the major lows in the early 1970s and late 1990s.

The years leading into these booms were marked by massive undervaluation of commodities against the U.S. market (marked by the circles on the graph above).

Yet commodities are now hovering well below those previous undervaluation periods.

It’s why you should consider the possibility that the next commodity boom could be the largest yet.

Fundamentally that makes sense. This cycle, as in every commodity cycle gone by, sees investment flood away from mining or the ‘old economy’ into new-age tech investments, chiefly into U.S. markets.

A decade or more of underinvestment in project development and new discovery places a firm grip over commodity supply. That’s the key ingredient to bring on much higher prices.

We’re yet to see the effects of underinvestment play out in commodity markets. But history suggests a massive asset transition looms.

A shift from the new economy BACK to the old is about to take place. There’s no reason to believe ‘this time’ will be any different.

That observation is backed by one of the leading commodity research firms, Goehring & Rozencwajg.

According to the firm’s analysis, commodity prices are at their most undervalued levels in 120 years! The only other times we were close to this level of undervaluation was back in 1929, 1969, and 1999.

Each of these periods was followed by a multi-year secular bull market in commodities that dramatically outperformed all other asset classes. According to Goehring & Rozencwajg, this cycle will be no different.

Curiously, their analysis also threw up some other surprising observations, as you’ll note from the graph, one of these undervaluation years occurred just prior to the Great Depression — 1929.

We all know economies in the West crashed that year and remained depressed throughout the early 1930’s.

But few realize commodity stocks actually boomed during this cataclysmic financial event.

According to G&R (emphasis added):

“A simple equally weighted portfolio of energy, base metal, precious metal, and agricultural stocks bought at the market peak in 1929 more than doubled by 1938 compared with the broad market that remained 50% lower. Indeed, owning commodity stocks throughout the Great Depression was the only way to preserve one’s wealth. Given the concerns of an impending recession, those worried about resource investing should take note.

During the 1970s, a similar portfolio split evenly between the four [commodity] sectors advanced by 500%. While the S&P 500 managed to advance by 170%, it barely kept up with infla­tion. Investing in natural resource equities was one of the few ways to grow purchasing power. From 1999 to 2010, there were two massive market pullbacks (the dot com bubble and the Global Financial Crisis) and the most significant financial crisis since the Great Depression. While the S&P 500 was flat between 1999 and 2010, with great turmoil, a similar portfolio of resource equities surged by 300%. Again, resource stocks were one of the few ways to avoid the calamities of the early 2000s.”

So, there you have it!

Right now, commodities offer an enticing investment theme that not only seeks to achieve asset appreciation but a strategy of potentially protecting your portfolio against stubbornly high inflation and financial volatility.

That’s what history shows.

In terms of growing wealth, investors have a clear choice. Own grossly OVERvalued U.S. equities and chase this tech boom higher or capitalize on the investment-starved mining sector and prepare for one of the biggest comeback stories in history.

As mining stocks emerge from the dust, now is the time to invest in the “old” economy.

— This column was previously published in Livewiremarkets.com.  

James Cooper is a geologist and mining analyst. Based in Melbourne, he’s now the resident commodities analyst at Fat Tail Investment Research and editor for the Diggers & Drillers Publication. You can follow him on X (Twitter) @JCooperGeo.