What is the scarcity principle in economics

Scarcity is one of the key concepts of economics. It means that the demand for a good or service is greater than the availability of the good or service. Therefore, scarcity can limit the choices available to the consumers who ultimately make up the economy. Scarcity is important for understanding how goods and services are valued. Things that are scarce, like gold, diamonds, or certain kinds of knowledge, are more valuable for being scarce because sellers of these goods and services can set higher prices. These sellers know that because more people want their good or service than there are goods and services available, they can find buyers at a higher cost.

Scarcity of goods and services is an important variable for economic models because it can affect the decisions made by consumers. For some people, the scarcity of a good or service means they cannot afford it. The economy of any place is made up of these choices by individuals and companies about what they can produce and afford.

The goods and services of any country are limited, which can lead to scarcity. Countries have different resources available to produce goods and services. These resources can be workers, government and private company investment, or raw materials (like trees or coal). Certain limits of scarcity can be balanced by taking resources from one area and using them somewhere else. Sellers like private companies or governments decide how the available resources are spread out. This is done by trying to strike a balance between what consumers need or want, what the government needs, and what will be an efficient use of resources to maximize profits. Countries also import resources from other countries, and export resources from their own.

Scarcity can be created on purpose. For example, governments control the printing of money, a valuable good. But, paper, cotton, and labor are all widely available across the world, so the things required to make money are not themselves scarce. If governments print too much money, the value of their money decreases, because it has become less scarce. When the supply of money in an economy is too high, it can lead to inflation. Inflation means the amount of money needed to buy a good or service increases—therefore money becomes less valuable, and the same amount of money can buy less over time than it could in the past. It is therefore in a country’s best interest to keep its paper money supply relatively scarce. However, sometimes inflation can help an economy. When money is less scarce, people can spend more, which triggers a rise in production. Low inflation can help an economy grow.

“The first lesson of economics is scarcity: there is never enough of anything to fully satisfy all those who want it. The first lesson of politics is to disregard the first lesson of economics.” - Thomas Sowell

Looking at the discussions surrounding the Russian oil prices cap, when it came to selecting our title analogy we reminded ourselves the “Scarcity Principle”. The “Scarcity Principle” is an economic theory that explains the price relationship between dynamic supply and demand. According to the scarcity principle, the price of a good, which has low supply and high demand, rises to meet the expected demand. Of course as highlighted by the quote above from Thomas Sowell, indeed, the first lesson of our politicians has been to ignore this basic economic principle. For instance, the oil price cap or EU ban on sale of new petrol and diesel cars from 2035 do not seem to take into account “dynamic supply” (An EV requires 2.5 times as much copper as an internal combustion engine vehicle). On average, an EV needs between 6kg and 12kg of cobalt, which translates to about 120,000 tonnes a year. More than 70% of the world's cobalt is produced in the Democratic Republic of Congo, and any nation that produces electronics wants in on that source. But, based on operational mines and projected demand, forecasters predict that supply won't be able to keep up with demand by 2030, or even as early as 2025. For electric cars (EV) you need to source commodities in “size” and we are not even discussing the urgent need for new nuclear plants. Unfortunately for us, our current batch of leaders live in a “different reality” and do not seem to grasp basic economic theory when it comes to commodities supply and inventories, end of our rant.

In continuation to our previous conversations relating to “risks assessments”, we would like to look at the now famous “pivot” narrative and what it entices when it comes to “risk assets” and potential for a potential “rally” in asset prices as well as some “tactical views”.

Pivoting the narrative

While overall global CDS 5 years YTD indices have rallied during the course of October on the “hope” of a Fed “pivot”, we still think it is way too early to expect the Fed to change its hiking narrative:

CDS GLOBAL (Datagrapple.com)

We have seen a tightening in CDS indices since our last conversation (from 492 bps to 434 for US High Yield vs 373 bps to 338 bps in European names). While we still expect an acceleration in the widening in European credit vs US in upcoming quarters as Economic data deteriorates furthers as seen in weaker PMIs, the rally in October was significant.

As we posited in our previous conversation the bear market rally in credit markets was depending entirely on bond volatility receding as per below YTD MOVE index:

MOVE INDEX (TradingView)

Bond volatility fell by 16% during the month of October, preventing in essence further rapid decline in credit markets already badly mauled by “convexity”.

Whereas every financial pundit is focusing on the “hiking path” taken by the Fed and “hoping” for a “pivot”, we think that the “pivoting narrative” would not be the “right reason” for a “massive” rally in risk assets but, rather some “geopolitical” progress relating to the ongoing conflict in Ukraine. As such, for cues, the results of the United States midterm elections are paramount as well as the upcoming G20 summit in Bali. “Conflict fatigue” seems to be setting in with the acceleration of the deterioration of the economic picture on top of growing rifts within the European Union. Countering the potential “rally narrative” on easing of geopolitical tensions, a full re-opening of China would bring in more inflationary pressure and would trigger a significant rally in commodities in that context:

Stagflation Risk (Bloomberg)

As pointed out by Gigi Penna on our Twitter feed:

“You do this math. Chart below shows Chinese stocks (white) and global mining stocks (blue)

China Vs Metals (Bloomberg)

A tiny sniff of a China reopening last week – BANG - copper is +5.5%.

What if the Chinese stock market rallies 20%?” – Gigi Penna

China reopening for Copper would be extremely bullish for the metal:

China Copper (Bloomberg Twitter)

As such, risk-reversal strategies in the current environment of “uncertainties” would help protect directional trades (traders often use risk reversal option strategies to hedge their bets and profit in the event of an unexpected rally).

Returning to basic “supply” economics 101, global copper shares have fallen to perilously low ranges and commodities giant Trafigura has issued a warning. True to the “Scarcity Principle”, limited inventories increase the danger of a sudden spike in costs if there were massive drawdowns and the need amongst merchants to secure safe supplies:

Copper stocks (World Data - @ArneLutsch Twitter)

On top of this many financial pundits are pointing towards very low inventories of Copper:

Total Copper Inventories (Twitter)

Copper inventories are at an all-time low. That's 3 days of global consumption in visible inventories. As such, copper prices could rise very significantly. No wonder recently the price rose by 8%. This is the pure application of the “Scarcity Principle”. Companies that need copper, will vertically integrate mining into their business. That’s a given:

Commodities YTF (Macronomics - KOYFIN)

This is the rub, how can one believe in the Fed “pivot” if inventories are running low in major commodities? We already know that oil markets are tight. US Frackers are telling us that Oil Production is slowing in the Shale Patch. As such, U.S. oil-and-gas companies offer little relief for tight global markets.

Right now the Fed is busy tightening financial conditions and the US money supply growth (YoY) has collapsed :

US M2 (YCHARTS - Twitter)

The Fed seems intended to drive the economy into the ground. This suggests there is more downside from there for equities than we think. If indeed the Fed continues with its tightening stance, then inflation should start to slow down with “demand destruction” but given how high oil markets are, stagflation should continue to be we think the overall outcome.

Tactical views

We have long indicated our fondness for “contrarian views” over the years such as betting against the “ESG cult”. As such, in December 2020, we recommended our viewers on OHM Research to take a look at coal plays, and in particular troubled BTU which was trading around $5 at the time and as well dividend play ARLP (less volatile). We continue to view positively the coal sector in the light of the burst of the “ESG bubble”. “Renewables” or not, it takes around 1 ton of coal to power the average residential solar system for one year because it takes approximately 1 ton of coal to power 7200-kWh. The raw material for the solar panels is coal, with an average life of 11 years. This means that 11 tons of coal must be burned to make a solar panel. Looking as well at the “energy crisis” unfolding in Europe, with Germany firing up more coal plants in the process. We do remain “bullish” overall for the sector:

BTU VS ARLP (TradingView)

Regardless of the transition “gurus”, coal is here to stay for longer:

FOSSIL FUELS (OUR WORLD IN DATA)

In relation to “global trade”, when it comes to “shipping stocks”, and looking at the current headwinds thanks to the fall in shipping rates, we continue to only favor LNG players in the space such as GLNG and GLOP:

Shipping stocks (Macronomics - TradingView)

The HARPEX (HARPER PETERSEN Charter Rates Index) reflects the worldwide price development on the charter market for container ships. In 6 months the index has collapsed from record high 4586 in March to around 1387, in effect doing a round trip in 24 months. As well, the latest Drewry WCI composite index of $3,050 per 40-foot container is now 71% below the peak of $10,377 reached in September 2021. It is 19% lower than the 5-year average of $3,754, indicating a return to more normal prices, but remains 115% higher than average 2019 (pre-pandemic) rates of $1,420.

Maybe and just maybe, some may feel we have seen the bottom for ZIM and given their generous dividends policy, it might be worth taking a punt for only the braves out there. We do have to see some “stabilization” in shipping rates. The outlook for 2023 doesn’t look that positive on the global trade front according to Danish giant AP MOLLER MAERSK.

“No complaint... is more common than that of a scarcity of money.” - Adam Smith

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During my career I have had different roles within various banks, covering various products, from FX to High Grade Bonds. I have always been passionate about markets and particularly on Macro trends. I am currently working in different role in another company and still in contact with the credit market business.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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