Too early to call a commodities supercycle

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The sharp rise in commodity prices from the depths of the Covid-19 lockdown is fuelling talk of a commodities supercycle with the greening of the global economy replacing fast-paced Chinese industrialisation as the structural driver of demand.

But we think caution is warranted.

The long history of commodity markets shows that supercycles take from 20 to 70 years from peak to peak. The last one followed the transformation of China in the mid-1990s and is still not fully spent in our opinion. These long swings are caused by insufficient investment in capacity and therefore the booms are spaced out.

Supercycles are not easy to distinguish and should only be called after careful analysis. The recent commodity bull market has been fed by several forces and we believe that most of these are temporary in nature and are insufficient to drive a supercycle.

The first and most obvious driver is the robust recovery in China. This was largely down to a Rmb 6tn fiscal stimulus package — equivalent to 6 per cent of GDP — that was disproportionately poured into the commodity guzzling construction sector. We do not expect stimulus on that scale to be repeated by China in coming years.

Moreover, China’s new dual circulation strategy, focused on cutting its dependence on overseas markets, aims to transition its economy to one driven by consumption. That will lead commodity demand growth to slow. 

The second factor driving the rally in commodity prices and equity markets more broadly is vaccine driven optimism. A belief that 2021 will be a year of recovery for the world outside of China. Panglossian views cannot drive a supercycle.

Third, investors fearful of higher inflation are shifting assets into gold and copper as a hedge. Markets expect large-scale pandemic stimulus to give rise to inflationary pressure. Particularly in the US, where if president Joe Biden’s latest package passes Congress, total pandemic stimulus would reach $5tn, or 25 per cent of GDP.

These are big numbers but as Janet Yellen has said, the Fed has tools to deal with inflation. We believe they will use them. Our view is that inflation fears are premature, and not enough to drive a supercycle. Although those who grew up in the 1970s, seeing inflation and commodity price rise together might disagree. 

Finally, metals prices are being buoyed by expectations that climate ambition will turn into action in the run-up to the UN climate meeting, COP 26, in November.

Decisive climate policy has the potential to supercharge the demand for key metals, such as copper, nickel, lithium and cobalt. Those materials are necessary to build low carbon infrastructure, such as solar panels, wind turbines, electric vehicles and charging stations. But only when concrete policies are announced on the energy transition can we be more confident of large scale demand growth. 

Commodity prices are driven by supply as well as demand. It is true that on current projections, there will be sizeable supply gaps in some mining commodities by 2030. In copper and battery grade nickel, we estimate the deficits are around 20 per cent.

Finance remains a challenge for the mining industry, where environmental, social and governance monitoring has intensified. However, large mining companies could potentially sidestep these barriers if consumers continue to buy their products, particularly if these products are needed to support a greener lifestyle.

If the consequence of environmental pressure, populism and supply chain security concerns is for governments to take a greater interest of mines and plants, this does not bode well for the ability to remove excess supply or lossmaking capacity. 

Climate action is the only factor that has the potential to drive a multiyear commodity price rally. But a lot must be said and done before that materialises. It is too early to call a supercycle. Commodity producers, investors, and financiers would do well to take heed.

Jumana Saleheen is chief economist and Lavan Mahadeva is research director at CRU, a consultancy

The Commodities Note is an online commentary on the industry from the Financial Times

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