Researchers at J.P. Morgan, Bank of America and Goldman Sachs have forecasted a major incoming commodities ‘super cycle’ as prices of metals, oils and grains have all surged to multi-year highs on a bull run that started in the summer of 2020.
The term ‘super cycle’ refers to the observable price fluctuations of resources that have occurred steadily over 10–20-year periods when adjusted for inflation. These cycles occur because of a supply-side stickiness, inherent to commodities markets. For instance, the International Council on Mining & Metals (ICMM) state that it can take 10 years for a mine to process a new deposit discovery through to production, meaning when a new industrial use or consumer exigency creates abnormal demand for metal, miners are slow to respond and buyers bid up the prices. These prices then fall when producers overestimate demand – they invest in new production-augmenting technologies and new projects which flood the market with supply. Prices fall when this supply excess reaches the market and is combined with procurers investing in alternative technologies or substitutes in response to a prolonged period of high rates. The resulting vicissitudes in price levels can be seen in Figure 1 below.
Figure 1 : Graph showing a 10-year rolling compound growth rate with a long-term polynomial trend at each end (red and blue lines). The pale blue dotted line illustrates a forecast estimation and prices used are from varying commodities indices tracking the prices of grains, oils and metals. Source: Stifel Report, June 2020.
Interestingly, when dealing with a basket of commodities, as in Figure 1, the changes in price can be mapped alongside major historical events. These include U.S. industrialisation in the late 19th century, WW1, WW2, and the peak preceding the current trough has been attributed to the Chinese mass consumption of raw materials that fuelled the country’s rapid economic growth around the turn of the millennium. Since reaching a high in 2008 and after the recession in 2009, the value of futures contracts (the most common commodity trading contract) has been in general decline and in March last year it reached a new low when COVID-19 first shocked the financial markets.
A consensus is building that the nadir of the trough has been reached, and analysts are now forecasting a prolonged period of rising prices in response to a multitude of factors, namely the global green energy transition, the inflationary effects of record-high levels of fiat currency expansion and booming growth in Asia as a large younger demographic enters the workforce and demands infrastructure and housing.
One metal thought to be at the heart of this upswing is copper, which has nearly doubled in price since March of 2020. Copper is currently the best, widely available conductor of electricity and heat, rendering it vital to the transition from fossil fuels to electric power as developed economies strive to meet emissions targets in the near future. Electric cars, for example, require 3.5 times more copper than their diesel and gas counterparts, according to natural resources specialist Wood Mackenzie, and consumers in the U.K. will only be able to buy hybrid/electric cars from 2030 – if Boris Johnson’s 10-point plan remains on schedule. In the face of this rising demand, commodities trader Trafigura has projected the creation of a 5 million tonne supply gap by 2030 (around 18% of current annual copper demand), and investment bank Jefferies estimates that a steady price of around 8800 USD/KG (5% higher than the current level) will be required to justify investment in new projects for mining companies. This poses a problem for these producers that will certainly require capital injections if they are to expand their operations into areas such as Siberia where infrastructure remains weak. With this in mind, one can begin seeing the supercycle concept in action, as supply-side stickiness supports a higher copper price for the next decade. Similar market forces can be extrapolated to other metals and rare earth materials used in electronics, for instance lithium, silver and neodymium.
In addition to these supply/demand forces, commodities have been added to portfolios by institutional investors in response to inflationary effects in the U.S. and increased growth in emerging markets. For inflation, institutional investors have turned to commodities as ‘safe haven assets’ in response to record levels of money printing by the Federal Reserve to stimulate the economy as the pandemic continues. Commodities are dollar-denominated and have an intrinsic value so theoretically become more valuable as more dollars are circulated, as owning them can offset fluctuations in the value of the currency. According to investment fund service provider Ntree Ltd, 50 billion USD flowed into precious metal-backed funds in 2020, more than double that of 2019, demonstrating the scale of this shift in thinking. Finally, continued development in the East is also expected to cause greater commodities purchases and push prices up. The International Energy Agency (IEA) published a report this week which estimated India’s energy demand will grow 70% in the next 20 years if leaders stand by their stated policy initiatives – highly significant when compared to the U.K. government’s forecast of just 2% growth in demand over the next 15 years. Regardless of how ‘greenly’ India and other developing countries source their energy, the massive investment required in fossil fuels, metals and rare earths necessary in industry will certainly contribute to an upswing in commodities prices worldwide.
By Stan Clark
Sector Head: Edouard Nelson