The narrative around a “new commodities supercycle” has received a lot of airplay in recent years. Commodities have seen a material rally in prices from their 2020 lows, which only adds fuel to the narrative. It is a worthwhile exercise considering the opposing argument in this narrative – what is the market missing?
There have been 4 widely noted commodities super cycles in the past:
(1) peaking in early 1900s, driven by the second industrial revolution (electricity, petroleum and steel);
(2) peaking in late 1940s, driven by the second world war rearmament and subsequent rebuild;
(3) peaking in late 1970s, driven by the reindustrialization of Europe and Japan;
(4) peaking in 2011, the last boom was largely thanks to emerging markets BRIC – Brazil, Russia, India, China – but in particular it was the industrialization of China that was the driving force behind this cycle.
Since March 2020, commodities have awakened from their slumber and have seen a broad-based rally in prices. Commodities super cycles last multiple decades, so investors want to be on the right side of this trade.
Figure 1: Bloomberg Commodity Index (Source: Banyantree, Bloomberg)
The question is what can go wrong with this positive narrative and what if the recent rally in prices from their lows in 2020 starts to fizzle out? We nominate a few reasons.
China’s stimulus fades away
Commodity prices tend to get a major boost on news of potential Chinese stimulus and growth in Chinese money supply. As we have previously highlighted, there is a strong relationship between higher commodities (iron ore, copper) and credit growth in China (government pumping stimulus to drive economic growth). The rate of change in the credit growth cycle in China has implications for equities and commodities. That is, should the regulators pull back on credit growth, commodities’ prices could be looking at their peaks (if not already). A similar story played out post the GFC, when commodities demand increased due to global stimulus in 2009 and 2010. But commodities’ prices fell away from 2011 (see chart above). Clearly, should China re-engage in extensive stimulus measures (including infrastructure build) then this will clearly be a positive for commodities.
Multi-decade demand outlook for oil is lower
We are bullish on oil near-term due to the supply / demand equation. However, over a multi-decade timeframe, it is likely oil is on a declining trajectory due to the acceleration of electrification and digitalization of global economies. Further, the near-term restraint shown by OPEC with respect to supply to support oil prices means there is supply waiting to come back online once prices are sustainably higher (i.e. when demand accelerates from current lacklustre global growth). The Bloomberg Commodity Index has a meaningful weighting towards oil and will be negatively impacted from a long-term decline in oil prices.
Could Bitcoin displace gold in portfolios?
Gold is another key commodity which makes up a large component of the Bloomberg Commodity Index. Gold appears to be fighting a battle with Bitcoin for a position in investors’ portfolios as a hedge against potential depreciation in value of fiat currencies and broader geopolitical risks (e.g. increasing multi-polar world driven by the fight for dominance between China & the U.S.). Gold being the tried and tested whilst Bitcoin still has several questions outstanding in investors’ minds. But what cannot be denied is the fact Bitcoin continues to gain wider acceptance (more companies accepting bitcoin as a method of payment, increasing ETFs dedicated to the space). The price of bitcoin may continue to rise on increasing acceptance and technological change.
“Greening” of economies is a positive but it’s not positive for all commodities
Decarbonisation thematic is definitely a positive for commodities from the perspective of the globally synchronised build-out of the green infrastructure. However, this process is long-dated and not all commodities benefit. Copper will be among the biggest beneficiaries from the green trend. However, other commodities such as agriculture and oil (as noted above) are not expected to benefit with the same magnitude. We are of the view that innovation in the food sector (e.g. plant-based meat) may lead to demand changes in soft commodities space as well.
What the above drivers suggest is that there is a danger of the commodities supercycle narrative losing steam. The most important near-term factor worth watching is the Chinese credit growth. If history is a guide and China continues to reduce money supply, then we are likely to see commodities come under pressure. This will obviously have implications for markets, sectors and currencies.
Investment Manager / Director at BanyanTree Investment Group
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