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Over the last few months, commodity prices have been on the rise, and increasingly more market participants are suggesting a new commodity super cycle. But what is this?

The United Nations (UN) describe it as a “decades-long, above-trend movements in a wide range of base material prices”, which differ from short-term fluctuations, in terms of span, with trough-to-trough cycles usually lasting 20 to 70 years, and in terms of range, affecting a broader spectrum of commodities, mostly inputs for industrial production and urban development.

Historical Super Cycles

Comparable previous Super Cycles include the mid 1940’s and 1950’s super cycle, during the reindustrialization and reconstruction of Europe and Japan (after World War II) and, later, aided by fears over the Korean War and its effects on South and East Asian trade, both of which led to a greater demand and a build-up of strategic inventories. As an example, the price of copper per long ton rose from $62.10 during WWII to $420 by 1954, an appreciation of 580% in 15 years.

More recently, in the beginning of the present millennium, commodities also saw their prices spiking, starting in 2000, up until 2013 (though a dip occurred between 2008 and 2010), mainly due to the rising demand from Emerging Markets, such as the BRIC countries, particularly China, which could not be accompanied by the supply side: the price of oil rose 1,062%, copper rose 487% and corn rose 240% from 1999 to 2008. It began showing slowdown signs after the great financial crisis and the Euro crisis in 2008 and 2011, while finally winding up during the 2015 Chinese Stock Market Crash, caused by the deceleration of the Chinese economy.  

Figure 1: GMO Commodity Index 1900-2013
Source: A roadmap for a smart Artic specialization

What is going on with Commodities

This present run, however, has started in March 2020, when markets reached their lows, with commodities’ prices plunging due to lockdowns and global stoppages of industrial activities. Since then, all major commodity indexes have recovered from their losses last year, mainly dragged by the momentum of Oil (up more than 180%), Gold (up more than 15%) and other specific metals, such as Copper and Silver (up more than 100%).

What are the factors driving this new commodity Spike?

The current commodities appreciation, and prospects of a new super cycle since the election of Joe Biden, have been caused mainly by three different forces. Two coming from short-run scenarios: Future Shortages of Supply and Inflation Expectations; and one from a long-run trend:  The Green Transition.

Starting off with the hypothesis of Future Shortages of Supply, this event is expected to be triggered as mass vaccinations and reopening of economies boosts the demand of multiple commodities, whose capacity has been depressed after the 2020 reductions in Capital Expenditure (CapEx), -25% on average for Oil and Gas companies.

Nevertheless, corporations from many other industries, that were forced to divest their activities during the demand crisis last year, are now about to be blessed by worldwide pandemic relief programs that have promised public large-scale infrastructure projects, such as the $10 billion Highway Infrastructures Program in the US and the $26 billion Investing in Canada Infrastructure Program.

Figure 2: CapEx cuts on the largest Oil and Gas companies
Source: Bloomberg

Secondly, the US loose monetary and fiscal policies, alongside a foreseen economic expansion, has left space for concerns regarding a prolonged inflationary and currency devaluation period that will highly benefit investors holding commodities on their portfolios. This asset class may have played a very timid role last decade, but with the Fed targeting an average of 2% inflation, instead of having this value as a threshold, and with investors looking to hedge their Fixed Income and Speculative positions, a commodities momentum has been building recently.

If we look at historical data, there has been a positive correlation between commodity prices and the CPI, with an increase of 1% in inflation resulting, on average, in a subsequent 3.5% appreciation of the BCOM (Bloomberg Commodity Index)

Figure 3: Scatter plot of the quarterly returns of the BCOM and changes in US CPI
Source: Bloomberg, NN Investment Partners

Finally, the transition for environment-friendly alternatives and new technologies, starting this decade, is likely to reshape the near-future of many commodities. On one side, the promotion of renewable energies from the US, Europe and China is going to require large investments for the creation of solar panels and wind turbines, which will pump up demand for metals such as Silver and Copper. Then, the incentives for an EV transition are also going to further risen the demand for other metals, such as Lithium, Cobalt and Nickel, required for its batteries.

However, on the other side, this transition is likely to have a contradictory effect on oil prices. Whilst these are expected to decrease in the Long-Run (given the decarbonisation process), the US re-entry into the Paris Agreement, in which it will agree to decrease its oil production by millions of barrels, will give the OPEC+ the opportunity to control even further the price of worldwide crude. Furthermore, as these countries seem to show no interest in the subject of climate change, they are set to leverage on what might be the last decade of strong demand for this commodity, thus pushing prices as high as they can.

Impact of a super cycle in the Economy              

Fluctuating commodity prices have a significant impact on business, but they also impact markets and the overall economy. Generally, the impact of commodity price fluctuations depends on whether that economy is a net importer, which typically benefits from the reduction in prices, or net exporter of commodities, which should be better-off with price increases.

Oil is the most important commodity for most economies worldwide.It is crucial, because it plays an important role in power generation, logistics and industry. If the price of oil increases due to higher demand, it is a good sign for the global economy, which will continue to expand alongside with the oil price. The intuition behind is that the increased production and consumption in the economy will generate the demand for oil. On the other hand, when the increase in price is due to a supply deficit, it normally means a potential contraction in the economy. Most of these shocks are associated with natural disasters or agreements by oil producers to fix the price.

Copper is sometimes named “Dr. Copper” for its ability to predict where the global economy is heading. When its price increases, the economy is normally on an uptrend. Other commodities, such as Timber, Cotton, Wheat, Corn and Coffee are broadly used throughout the economy. An increase in their price means that the prices for the products they input will increase.

Lastly, it is important to mention Gold, given its special characteristics. It is used in various sectors across the economy and its price also depends on the value of the US Dollar. Contrary to other commodities, gold price normally goes up when the economy is in bad shape, since it is seen as a stable investment.

Future Perspectives

As the world re-opens, demand for commodities has surged throughout countries. Combining this with rising inflation, a weaker dollar and low interest rates, resulting from the highly expansionist monetary policies in response to the pandemic crisis, it might create a new super cycle in commodities in the US, as investors and businesses demand commodities either to hedge these risks or for production. Also, as the US looks to join the Paris agreement, infrastructure will have to be built to meet the requirements.

Overall, the conditions seem favourable for a new super cycle to be starting. Nevertheless, some of the drivers might not play out as expected or even be a temporary glance that won’t be able to impact commodities price on the long run and sustain the cycle over time.

Sources: Australian Financial Review, Blackwell Global, BRINK, Business Insider, NN Investment Partners, The Economic Times, United Nations Industrial Development Organization

Scientific revision: Patrícia Cruz

Francisco Nunes

Jorge Lousada

Diogo Almeida

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