Commodity Watch: Rubber’s Supply Shock

<div class="grid grid--33-66-col"><div class="col"><img loading="lazy" src="/getContentAsset/061c994a-a452-418f-bfa0-f2cf3cf5c577/cb87803a-320c-480f-ab75-7b9029eaaf79/Ahmad-Al-Sati-new.png?language=en" alt="Ahmad Al Sati - insights" title="Ahmad Al Sati - insights" style="width: 180px" class="fr-fic fr-dii"></div><span style="font-size: 12px"><div class="col"><strong>AHMAD AL-SATI<br></strong>PORTFOLIO MANAGER<br><br><p>Ahmad is the President and Portfolio Manager for Gemcorp Capital Advisors LLC, based in New York.&nbsp;<br><br>Ahmad has spent most of his career in the global credit markets. Prior to Gemcorp, Ahmad was President of Pandion Mine Finance and RiverMet Resource Capital, LP - a fund focused on investing in precious metals, where he was responsible for managing the investments and the day-to-day operations of the registered investment adviser.&nbsp;</p></div></span></div><hr><p>On 2.5 million acres in the Amazon, Ford tried to secure rubber. Fordlandia was supposed to break the British stranglehold on natural rubber (Britain produced 75% of the world’s rubber while the US consumed 75% of it). Fordlandia failed. In addition to labour (Ford wanted Brazilians to eat a Midwestern diet) and soil issues (rains eroded the fertile soil once original trees were cut down), the plantation suffered from South American Leaf Blight (SALB), which destroyed the indigenous Havea brasiliensis (rubber) trees and made the soil inhospitable. In nature, rubber trees grow far from each other. Plantations where trees are grown close effectively created a petri dish where SALB thrived.</p><p>Rubber in Brazil did not recover. Today, Asia (no SALB) produces 90% of natural rubber. Rubber remains an important part of the global economy. It is valued because it is elastic, durable, water resistant, acts as an electricity insulator, disperses heat quickly, has high tensile strength and is low maintenance. As such, over 50 thousand products use it. It is used for tires (airplane tires are 100% natural rubber), medical devices (tubes), construction (roofing) and defence (stealth submarines are painted with rubber to evade sonar).</p><p>Rubber prices peaked at the end of the last commodity super cycle (2012) and experienced low prices since. Thus, farmers pivoted to more profitable crops such as palm oil. But economic growth and new technologies (EVs require more rubber in tires because they are heavier) meant that supply failed to keep up with demand. Prices have reached a 13-year high as the world experiences shortages for the 5th year running. Despite higher prices, demand cannot be met quickly as it takes seven to ten years for a tree to mature. Production is also controlled by a few countries and rubber trade routes go through the South China sea (think the Strait of Hormuz for rubber). Synthetic rubber is not an effective substitute for many uses, and, in any case, China controls the supply chain for synthetic rubber.</p><p>Sound familiar?</p><p>After a decade of underinvestment and neglect, a slew of key commodities are suffering rubber’s fate (think rare earths and copper). Although higher prices will ultimately fix low supply, the lag time will be substantial and the intermediate period volatile. Twice, over the last 60 years, the world underinvested in commodities (1960s and 1990s). And twice afterwards, we saw fragile supplies succumb to supply-side (OPEC) and demand-side (China) shocks as overall commodity prices subsequently skyrocketed (were the early 2020s a precursor?).</p><p>A change in commodity prices has serious implications for portfolios and economies as inflation eats into income and returns (a rise in the price of rubber across 50 thousand products is inflationary no matter how you cut it). The solution for lower prices is simple: more investment. But that takes time. Proofing portfolios against the corrosive impact of higher commodity prices (or even benefit from them) should perhaps be top of mind for investors and allocators.</p>