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09 jul 2021

A commodities supercycle: what it means and why it matters.

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As the prices of oil, iron ore and copper have surged in recent months, there’s been much talk about a commodities supercycle. But what does this mean, and why does it matter? Jean-Baptiste Berthon, Senior Cross-Asset Strategist at Lyxor Asset Management, gives us an overview, and highlights the key role of copper in the energy transition.

In a regular commodity cycle, prices rise with demand. Commodity producers increase production until supply outstrips demand, and prices then fall back. In a supercycle, however, supply fails to meet demand for a prolonged period, so that commodity prices continue to rise for years or even decades. 

What stops supply from meeting demand? Well, companies need time to build the capacity to mine more metals or extract more oil. And they need more time still to hire and train workers. This can take years. So when demand rises more sharply than producers have anticipated, they can struggle to catch up. That’s when a supercycle can set in.

A century in supercycles

Historically, supercycles have arisen from profound changes in the way we live – changes that drastically increase our appetite for commodities. In the past 120 years, there have been four such supercycles.

The first began in the 1890s as US industrialisation got underway. This supercycle continued through to the end of the First World War, fuelled by demand for armaments.

The second started in the 1930s and persisted until the 1950s. It was driven by the widespread adoption of the motorcar and by the Second World War. 

The third ran from the late 1960s until the early 1980s. It accelerated in the 1970s as tensions in the Middle East interrupted the oil supply. Eventually, however, alternative sources of energy led to the 1980s oil glut.

The most recent supercycle began when China entered the World Trade Organisation in 2001. China’s economic reforms and massive urbanisation drove demand for commodities to new highs. In 2008, the global financial crisis brought this to an abrupt halt. 

Supercycles in commodity prices (BCPI weights,* 1899-2016)

Supercycles

Source for data: Bank of Canada. *Economists at the Bank of Canada used the Bank of Canada commodity price index (BCPI) to search for evidence of super cycles using an asymmetric band pass filter. This is an index of the spot or transaction prices in US dollars of 26 commodities. Original chart comes from Visual Capitalist: https://www.visualcapitalist.com/what-is-a-commodity-super-cycle/
Past performance is not a reliable indicator of future results.

Where to now?

Could we be in the early stages of a new supercycle? There are some signs that we might be. This time, the profound changes could be the Covid crisis and the energy transition. As oil and metal prices have rocketed in recent months, producers have struggled to meet demand. Many cut their capacity in response to the US-China trade war and the Covid pandemic, and there has been little investment in new capacity.

And demand is set to rise further still. As Covid-19 vaccines are rolled out, economies are reopening. Governments have announced massive fiscal stimulus programmes, and central banks are keeping interest rates at or near zero. Low rates can help to fuel a commodities boom as people invest in commodities – notably gold – to achieve higher returns and escape inflation. Meanwhile, the US dollar has weakened recently. Because commodities are traded in dollars, a weaker dollar can stoke demand.

Is it different this time? 

If a supercycle does get underway, it’s likely to differ somewhat from its predecessors. That’s because much of the world’s planned fiscal stimulus has a distinctly green tinge. President Biden’s American Jobs Plan includes investment of $174 billion in electric vehicles, alongside commitments to clean energy and green infrastructure. The European Union has announced the biggest-ever green stimulus package at over €500 billion while the UK has committed to ‘build back better’. And China has announced ambitious carbon-emission targets for the decades ahead. 

if a supercycle

This emphasis on the energy transition means that any nascent supercycle is likely to be driven by copper rather than fossil fuels. The price of copper hit a record high in May. Copper is used in both traditional and green infrastructure. It also has a crucial role in the manufacture of electric vehicles.

We expect a copper shortage later this year. The current surge has been driven by demand from China and exacerbated by Covid-driven disruption at mines in Chile and Peru. Although Chinese demand will probably moderate, the rest of the world should take up the slack. So the copper price looks set for fresh highs.

Historical performance of copper (in $)

historical performance

Source: Lyxor International Asset Management, June 2021. Past performance is not a reliable indicator of future results.

The prices of oil and natural gas have risen dramatically too. The OPEC+ group has started to reverse its recent production cuts, but any new supply is likely to be absorbed fairly quickly. Meanwhile, US shale gas has only just turned profitable after years of losses, so cautious producers are keeping capacity unchanged.

The emphasis on clean energy in the various stimulus packages will not have an immediate impact on demand for fossil fuels; traditional energy is required to build green infrastructure. But the long-term implications are less clear. 

What does a supercycle mean for investors? 

Rising commodity prices signal one big thing: inflation. A boom in commodities will, sooner or later, lead to rising prices across the board. That’s bad news for bondholders; most fixed-income products don’t offer protection from inflation.

Then there’s the stock market. Previous supercycles have begun when commodity prices are low and stock prices high – precisely the conditions when the current surge in commodities began. Stocks are still trading at record levels, but that could also suggest that a supercycle is on the cards. Past supercycles have coincided with shares falling from their highs.

But not all stocks are equal. The share prices of materials and energy companies could do very well if a supercycle sets in. And other cyclical stocks could benefit from a commodities boom.

The case against

There are, however, some factors that could prevent a supercycle from taking hold. If China’s growth rate slows significantly, global demand for commodities would moderate too.

Technology is another wild card. Improvements in energy efficiency could reduce demand for fossil fuels. And so too could improved recycling and greater industrial digitalisation.

Finally, if the Biden administration is unable to implement its stimulus packages in full, we may not see a commodities boom on the scale that many expect.

If the events of 2020 taught us anything, it’s that our powers of prediction are limited. So a new commodities supercycle isn’t a certainty. But it is a distinct possibility – one that investors should take seriously when they think about how their portfolios are positioned. 

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