The Commodity Super-Cycle – a simple perspective

By: Seng Liew

Recent price movements have some calling for a new Super-Cycle. It is an important part of EM analysis. If we look at Commodity Super-Cycle, it is a permanent significant increase in commodity demand with supply unable to meet the demand, causing permanent price movement. The supply side being limited by the timeline of new mines coming online. 

 Global base metal demand per annum tends to grow at stable 3-5% per annum with many new projects in the metals and mining industry planned under the same assumptions. There will always be some short- term price volatility given the weather and natural disasters that impacts the supply side. Therefore, when we look at demand, we really need to look at what drives the demand surge given the well documented fundamental demand history.

Firstly, the trading of commodities on the futures exchanges have seen larger participations since Goldman’s recommendation back in the 1990s as a new investment asset class. Futures contracts have never been liquid enough to withstand price pressures exerted from the investment community and speculators. Even more liquid contracts, like crude oil, has its limitations. It still takes Pemex roughly 6 months to hedge half their annual production. The low interest rate environment also contributes to more violent price movements given the global leverage in commodity trading and positioning. Hence, we can expect price volatility to persist. 

Secondly, the most important driver on the demand side is global economic synchronicity. This has the biggest impact on commodity pricing and in turn inflation. We don’t need to look so far back given how much world economic drivers have changed. In simple terms, Pre-Dot.com bubble, different regions of the world were operating at different economic cycle and speed. We can divide the impactful world as Europe, N. America, S. America and Asia/Pacific. The Dot.com bubble burst reset, realigned and synchronized the global economic cycle and speed. Hence the 2000-2008 commodity cycle.

In 2008, the financial crisis effectively de-synchronized the world with each region recovering and operating at different cycle and speed. This de-synchronized world still exists to date. It is true that China has been the biggest driver of commodity prices. If we look back at commodities prices pre-pandemic, it has been relatively stable except for the early years of recovery from the financial crisis. It reflects the reasonable balance in demand and supply. Therefore, one should question if we are entering a new Super-Cycle, I would think not. 

What we have seen from the Pandemic is a sudden stop. A sudden stop has all traits of a recession but, is it really a recession? The initial rebound is indeed V-shaped, but one has to question its sustainability given the damage to the economy especially to the SMEs. In any country, irrespective of EM or DM, SMEs are the backbone of job creation and in turn consumption, not multinationals. Therefore, one would surmise that any initial V shape will morphed into a U-shaped recovery. In many EM countries which lacks resources in varying degrees, it will turn into an elongated U-shaped recovery. 

Conclusion: I would argue that there is no Super-Cycle here, but more of a normalization of demand. The heavy frontloading in demand from China can somewhat be explained by its seasonality and inventory rebuilding. Most Chinese construction stops in Winter and ramps up with the warming weather. Chinese speculative positioning and built-in leverage have always been extremely high. Unfortunately, this data lacks transparency until we hear of leverage defaults within China. Furthermore, Chinese growth is heading towards a lower trajectory driven mainly by its demographics. More importantly, Chinese debt dynamics is forcing the central government to allow for more controlled bankruptcies within their world of Zombie companies.