Co-produced with “Hidden Opportunities”
A supercycle is defined as an extended period of strong demand growth that suppliers struggle to meet, resulting in a rally that could last more than a decade. In the past century, there have been four great commodity supercycles with varying durations, intensities, and degrees of magnitude. Each of these supercycles has been tied to very transformational periods of global economic development.
- The 1910s - rapid industrialization of the United States in the late 19th century
- The 1930s - global rearmament before World War II
- The 1960s - re-industrialization of Germany and Japan in the late 1950s and early 1960s following WWII
- The 2000s - rapid industrialization of BRIC nations and their increasing dominance on global GDP from mid-1990s
In the early 2000s, industrialization and urbanization in BRIC nations, particularly China, resulted in a demand boom for metals. Copper, which is typically seen as the bellwether for metals, surged to $10,000 per metric tonne from under $2,000 between 2000-2010. During this period, crude oil jumped from ~$20 per barrel to reach its record high price of $147 per barrel in 2008.
Why could it be time for the next supercycle?
Several factors discussed below are providing hints of an upcoming commodities supercycle:
1- Demand from emerging economies
China and India are 38% more populated than they were in the early 90s.
In China, the government as well as industries imported record volumes of crude oil, copper, iron ore, and coal in 2020, a year when the global economy was frozen by the coronavirus outbreak.
India, with a reasonably large percentage of its population well-educated, has all the foundations to pursue substantial economic growth. While the country is currently facing challenges due to the pandemic, it is expected to overtake the U.K. to become the 5th largest economy by 2025 and stay on track to the 3rd spot by 2030.
Heavy demand for natural resources is expected in the decade ahead as these emerging economies continue to grow rapidly.
2- Underinvestment precedes a commodities cycle
A Barron’s article from April 2021 points out that underinvestment is the primary reason producers are unable to meet surging demand in lumber and semiconductors. We can see a similar pattern of declining investments in copper and crude oil.
Out of 224 copper deposits discovered between 1990-2019, only 16 have been found in the past 10 years and only 1 since 2015. This is as a result of less exploration for new discoveries.
Source: S&P Global Market Intelligence
An electric vehicle needs up to 4 times more copper than an internal combustion engine vehicle. Additionally, copper is essential in the charging station infrastructure rollout as well, making it an essential commodity for the green economy.
We can also see that global upstream spending for oil is at the range of its lowest levels in 15 years.
Source: Rystad Energy
If this declining investment is not reversed soon, a crude oil supply gap will impact us later this decade. While global oil demand is expected to peak by 2030, the world will continue to require large amounts of oil for several decades after this peak to satisfy the growing energy demand from the rising world population.
3- Weakening U.S. Dollar
A combination of the budget deficit and the current account deficit is seen as a long-term structural driver of a weaker U.S. dollar. The speed and size of government stimulus packages in response to the global pandemic have been unprecedented. As a result of the federal government pumping trillions into the economy, the twin deficits reached all-time lows earlier this year.
Source: LPL Research
The U.S. budget deficit rose to $2.71 trillion through August, on track to be the second-largest shortfall in history due to trillions of dollars in COVID relief.
Given the likelihood of a two-year gap between the beginning of the Fed’s tapering of bond purchases and the first interest rate increase, the dollar may struggle to rise past its current levels through the end of 2022
The value of the dollar is very important for commodity prices because the U.S. dollar is the benchmark pricing mechanism for most commodities. Commodity prices have an inverse relationship with the dollar value, so a declining dollar means rising prices.
Fiscal and monetary policies pursued by the government to stimulate the economy are resulting in soaring commodity prices and raising concerns about inflation.
Supply chains have been severely impacted with inventories depleted, large restocking orders, and high premiums on near-term deliveries of raw materials. Look at the year-over-year surge in prices of popular commodities.
The direct effect of inflation is soaring commodity prices, which erodes an investment portfolio. This is because average investment returns will be insufficient to combat rising prices.
5- China is Now Exporting Inflation
For decades, China was able to mock and profit from global inflation pressures by pumping deflation into the world. It was able to do so when needed to keep stagnant wages and manipulate its currency through low-interest rates.
Today, inflation "revenge" has caught up with China. Like everybody else in the world, China is dealing with all kinds of commodity shortages including copper, coal, steel, and iron ore, chickens, lumber, etc. China has its own supply problems and rising prices. While China hopes this is temporary, its economy has developed enough in recent decades, and workforce wages have risen enough, that the days when they can supply goods at "lower prices" to keep inflation at bay are over.
As material prices soar, China's factory-gate inflation has hit 13-year high levels. China is now set to be exporting inflation to the world. Given that China is facing high internal demand from its own population and that the earning power of its citizens is increasing, it is becoming virtually impossible to pressure its workforce to accept the "old cheap" wages that it used to pay its labor. Devaluing their currencies is no longer a viable option they can use either as an indirect way to lower their labor purchasing power. It all comes down to "scarcity of natural resources". No wonder why prices of all kinds of commodities are rising.
6- Impact of Climate Change on Agriculture
The Intergovernmental Panel on Climate Change (‘IPCC’) report from 2020 explains the effects of global warming on agriculture and points out that a 2°C increase in global temperature would significantly increase the risk of food supply instabilities.
We constantly see the impact of extreme weather conditions on agriculture output. The food system is already under pressure from non-climate stressors such as increasing world population, rising income levels, and growing demand for plant-based products. We saw in the above section how prices of wheat, soybeans, and beef have soared in the past 12 months. This is just the beginning. Climate change is making matters worse and has the potential to accelerate the impact on consumers globally through higher food prices.
7- The Race Towards Net Zero Emissions
Coal was the main driver for American industrialization in the nineteenth century. Coal provided a cheap and efficient source of power for steam engines, furnaces, and forges across the United States and was accompanied by technological innovations in mining, energy consumption, and transportation.
100 years later, the driver has changed. A growing number of countries are making commitments to achieve carbon neutrality in the upcoming decades. With net zero by 2050 as a common objective by leading economies in the world, massive infrastructure transformation will be necessary.
Replacement of coal power plants with sustainable alternatives, a shift to electric transport powered by renewable energy are a few among several transformations that we will be seeing. The evolution of battery technology to accomplish energy storage for improved grid reliability and to satisfy the increasing demand for electric vehicles brings focus to several metals such as cobalt, lithium, and rare-earth metals such as neodymium, terbium, and dysprosium that mankind has not widely exploited thus far.
We will be seeing an increased focus on technology innovations to improve the storage, transmission, and consumption of clean fuel to address the climate change agenda. As a result, global demand for commodities is set to soar.
8- Commodities are currently cheap
Commodities are among the few asset classes around the world that are still cheap not just in a comparison with equities but also with their historic prices.
Source: International Monetary Fund
As global economies begin to recover from this pandemic, the consumption and demand of commodities are set to soar.
9- The Fed has Limited Tools to Fight Inflation
Here, we need to note two items that are very important and that got the Fed's hands tied so they may be unable or unwilling to hike rates by too much to rein inflation:
- The Fed is not willing to risk derailing the economy and risk having another recession which will be extremely costly to "resolve", and probably more costly than the COVID crisis. I think this is out of the question for the Fed right now. This will tie the Fed's hands about how much they might be willing to increase the Fed Funds rate.
- Even if the Fed becomes very hawkish and willing to hike rates, it is going to face very tough opposition from politicians from both parties. Remember that the fiscal deficit has ballooned since COVID and any small increase in Fed rates is going to cost the government a fortune in interest payments to repay. At this time, the government is actually better off with persistent inflation, so the balloon of debt becomes more manageable with rising GDP.
Example - If you own a mortgage of $100,000 on a $200,000 home, and inflation drives the value of your home to $400,000, then your debt level (as a ratio of equity) is reduced immediately from 50% to 25%, which makes it more manageable. At the same time, GDP goes up, because the value of new construction has gone up. So you have an immediate reduction in the debt/GDP ratio.
If the government is faced with having to raise rates aggressively, they may settle for more inflation and less relative "Federal Deficit".
Because of both reasons above, I believe that the Fed has few tools to fight inflation or "runaway inflation".
The big commodity supercycle could come sooner than you expect. Today may just be when it all starts. More government spending, the unwillingness of the Fed to intervene to curb inflation expectations, the new global economy, global warming, and its impact on agriculture and food supply can suddenly turn the tables. The time for a new commodity supercycle is very near. It is still early in the game. You can still benefit by investing in commodities to hedge against the current and upcoming inflation that is for sure going to surge in the coming years.
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