Are commodities on the cusp of a new supercycle?

Fol­low­ing the dev­as­tat­ing impact of the coro­n­avirus pan­dem­ic on finan­cial mar­kets around the world, the recent surge in com­mod­i­ty prices appears to sug­gest grow­ing investor con­fi­dence for the future. 

Oil prices have jumped by around 20 per cent since the start of the year to pre-pan­dem­ic lev­els, while gold has soared to a new record. Mean­while, cop­per, which is often viewed as the bell­wether of the indus­tri­al met­als sec­tor, hit a nine-and-a-half-year high at the end of 2020, fuelling talk of a new com­modi­ties super cycle.

Price swings are par for the course in any mar­ket, but the term “super cycle” is reserved for the very largest fluc­tu­a­tions, when com­modi­ties rise above their long-term price trend for a lengthy peri­od, often sev­er­al years, even a decade or longer. 

The indus­tri­al­i­sa­tion of the Unit­ed States at the end of the 19^th cen­tu­ry and the post-war re-indus­tri­al­i­sa­tion of Europe and Japan in the late 1950s are two such exam­ples. More recent­ly, the rapid eco­nom­ic growth of BRIC coun­tries, most notably Chi­na, sent demand for com­modi­ties and with it, prices, soar­ing in the ear­ly years of the mil­len­ni­um.

But, the glob­al finan­cial cri­sis, cou­pled with slow­er than expect­ed Chi­nese con­sump­tion proved sig­nif­i­cant head­winds for the sec­tor, send­ing the S&P/Goldman Sachs Com­mod­i­ty Index plung­ing by 60 per cent over the course of the last decade. 

After lan­guish­ing in a bear mar­ket for the past ten years, 2020 saw com­modi­ties find favour with investors once again. The Bloomberg Com­mod­i­ty Index rose 10 per cent in the fourth quar­ter alone, prompt­ing ana­lysts to declare the sec­tor is dis­play­ing struc­tur­al sim­i­lar­i­ties to that of the ear­ly-2000s. 

Start of a new super cycle?

On the face of it, the signs are cer­tain­ly pos­i­tive. The Chi­nese Caix­in man­u­fac­tur­ing pur­chas­ing man­agers’ index reached a ten-year high in Novem­ber 2020, imply­ing increased demand for com­modi­ties. Mean­while, a weak­en­ing US dol­lar, com­bined with wide­spread fis­cal stim­u­lus, has stoked con­cerns of grow­ing infla­tion, against which com­modi­ties have his­tor­i­cal­ly been used as a hedge. 

Accord­ing to com­mod­i­ty ana­lysts at J.P. Mor­gan: “The past decade was marked by low growth and low infla­tion. Bonds and sec­u­lar growth stocks were in a bull mar­ket, while com­modi­ties and cycli­cal stocks per­formed poor­ly. We believe that the tide on yields and infla­tion is turn­ing.”

The new com­mod­i­ty upswing, and in par­tic­u­lar oil up-cycle, has start­ed. Most­ly, it will be the sto­ry of “post-pan­dem­ic recov­ery, ultra-loose mon­e­tary and fis­cal poli­cies, weak US dol­lar, stronger infla­tion, and unin­tend­ed con­se­quences of envi­ron­men­tal poli­cies and their fric­tion with phys­i­cal con­straints relat­ed to ener­gy con­sump­tion and pro­duc­tion”, says J.P. Mor­gan.  

Com­mod­i­ty bulls also stress the impact of the green indus­tri­al rev­o­lu­tion upon the sec­tor, with coun­tries across the globe vow­ing to spend big to meet cli­mate tar­gets. 

Chi­na, the largest ener­gy pro­duc­er and con­sumer in the world, recent­ly com­mit­ted to become car­bon neu­tral by 2060. Beyond Chi­na, the US Biden admin­is­tra­tion has set a new $2‑trillion green deal, while the Euro­pean Union has pledged to reduce green­house gas emis­sions by at least 55 per cent up to 2030, com­pared with 1990 lev­els. 

Ana­lysts at Gold­man Sachs believe this tran­si­tion has the poten­tial to cre­ate $1 tril­lion to $2 tril­lion a year in infra­struc­ture invest­ment, sur­pass­ing oil and gas drilling for the first time. 

Commodity headwinds 

While the build­ing blocks for a com­modi­ties price growth look to be falling into place, many experts warn it is too soon to label the recent upswing the start of a new super cycle. 

Scott Gard­ner, invest­ment strate­gist at Charles Stan­ley, explains: “For a com­mod­i­ty super cycle to occur, we need two macro fac­tors to be in play: a weak­er US dol­lar and above-trend eco­nom­ic glob­al growth. 

“A weak­er dol­lar can arise from fur­ther eas­ing by US author­i­ties and, giv­en the infra­struc­ture plan and com­mit­ment to the easy finan­cial con­di­tions from the US Fed­er­al Reserve, we cur­rent­ly have that con­di­tion. 

“Sec­ond­ly, we need robust eco­nom­ic growth glob­al­ly. Dur­ing the 2000s, as Chi­na emerged into the glob­al mar­ket­place, the demand for com­modi­ties increased dra­mat­i­cal­ly and helped fuel the 2000’s super cycle. We cur­rent­ly don’t have an emerg­ing eco­nom­ic super­pow­er at a sim­i­lar stage to where the Chi­nese were.”

Some ana­lysts believe that while there is an argu­ment for a more bull­ish mar­ket across cer­tain com­modi­ties, it is dif­fi­cult to antic­i­pate the same lev­el of demand for com­modi­ties such as oil, which makes up a sig­nif­i­cant pro­por­tion of the sec­tor. 

As a result, investors need to be aware of risks asso­ci­at­ed with broad-based com­mod­i­ty indices, says Gard­ner. 

“Depend­ing on the com­mod­i­ty index, ener­gy com­pris­es between 25 and 40 per cent of the index. Giv­en the increased hos­til­i­ty from gov­ern­ments and cor­po­rates glob­al­ly to tra­di­tion­al fos­sil fuels, this is a sec­u­lar head­wind. Investors should focus on spe­cif­ic com­mod­i­ty groups, name­ly met­als. There is also the sec­u­lar trend towards clean­er, green­er ener­gy via elec­tri­fi­ca­tion,” he says.

Indeed, lithi­um, a cru­cial com­po­nent of elec­tric vehi­cle bat­ter­ies is up 88 per cent this year, while pal­la­di­um, used in cat­alyt­ic con­vert­ers, reached record highs in 2020. 

Michael Hew­son, chief mar­ket ana­lyst at CMC Mar­kets, com­ments: “We are like­ly to see a shift in sup­ply and demand across cer­tain met­als. How­ev­er, off­set­ting that will be a decline in fos­sil fuels such as coal and oil. While one might argue that price spikes will occur, it will not be enough to war­rant being called a super cycle.”

Investors should avoid plac­ing all their eggs in one bas­ket. Hew­son says: “It’s impor­tant investors don’t focus on one par­tic­u­lar com­mod­i­ty, but rather cre­ate a bas­ket of com­pa­nies to diver­si­fy the risk.” 

He advis­es that investors could ben­e­fit from con­sid­er­ing com­pa­nies not direct­ly in the renew­ables sec­tor, but which offer ser­vices to these firms, as a way to gain expo­sure. 

While wis­dom has taught us to expect the unex­pect­ed when it comes to com­modi­ties, the jury remains firm­ly out on whether we are in the throes of a new super cycle. But one thing is cer­tain: com­modi­ties are like­ly to keep investors on their toes as we enter a new post-pan­dem­ic era.