From Commodity Price Action Springs Supercycle Thoughts
“Is the oil price climb in recent months just a rebound from the collapse last spring, or a signal of something else? Maybe after a decade of poor performance, conditions for a commodity supercycle are falling into place. ”
Last November, investment broker Goldman Sachs suggested that the world might be about to experience another commodity supercycle. This contrary view came after four years in which commodities were the last investment people wanted in their portfolios. “Looking at the 2020s, we believe that similar structural forces to those which drove commodities in the 2000s could be at play” was what Goldman wrote in its report. For energy markets, the recovery of global crude oil prices late in 2020 was perplexing, as demand, although having recovered somewhat from earlier economic lockdowns, was being hammered once again by a new virus outbreak. The emergence of a mutant of the Covid-19 virus that was more easily transmitted, but apparently less lethal, scared government leaders. With the new virus spreading, locking down economies was considered the only weapon to fight it. As government after government announced lockdowns, oil demand projections began to be discounted. Why were oil prices rising?
Maybe it was because the oil market was beginning to sense that the arrival of Covid-19 vaccines would return us to a more normal world economy in the foreseeable future. Traveling a path back to normality, even if there were bumps in the road such as the new mutant virus, seemed assured. Although returning to “normal” means many different things, its assurance sparks optimism. It means a much higher level of economic activity. That means more energy will be consumed – although debates about which fuels will benefit the most are ongoing.
Environmentalists and many politicians believe only renewables should benefit from the recovery. Others believe all fuels, including fossil fuels, will benefit from the demand recovery. While energy is in the spotlight, more economic activity means greater demand for all commodities. After years of little interest or investment in commodities, supplies may be inadequate to meet projected demand. That is the condition underlying commodity cycles. We can see how challenged energy fuels were over the past decade when looking at the performance of commodities. There was too much supply. Crude oil was among the three worst performing commodities for half of the last decade, while coal was in the same category four times.
Exhibit 22. Commodities Were Shunned During Decade SOURCE: Frank Holmes
According to a 2012 United Nations DESA working paper, “Super-cycles of commodity prices since the mid-nineteenth century,” supercycles are defined as a “decades-long, above-trend movements in a wide range of base material prices deriving from a structural change in demand.” Examples of such commodity supercycles would include the industrialization of the United States in the late 19th century, as well as the post-war reconstruction of Europe and Japan in the 1950s. The 2000s supercycle conformed to the same pattern, all though this time it occurred in the BRIC countries – Brazil, Russia, India and China.
Exhibit 23. Supercycles As Identified By Canada Economists Source: Virtual Capitalist
An article published in the summer of 2019 contained a chart showing the history of supercycles. The chart (prior page) was based on an analysis and data from Bank of Canada economists using their bank’s commodity price index to show the history of supercycles from 1899 to 2016 (the present at the time of the article). As the peak in the fourth supercycle was 2011, most commodity prices continued to fall until 2020, so the recent uptick in commodity prices might suggest that the last cycle has ended and the next has commenced.
The Bank of Canada economists utilized a statistical technique called an asymmetric band pass filter. This is a calculation that can identify the patterns or frequencies of events in sets of data. It was employed on their Commodity Price Index (BCPI) to search for evidence of supercycles. The BPCI is an index of spot or transaction prices in U.S. dollars of 26 commodities produced in Canada and sold to world markets. Those commodities included:
Energy: Coal, Oil, and Natural Gas.
Metals and Minerals: Gold, Silver, Nickel, Copper, Aluminum, Zinc, Potash, Lead, and Iron.
Forestry: Pulp, Lumber, and Newsprint.
Agriculture: Potatoes, Cattle, Hogs, Wheat, Barley, Canola, and Corn.
Fisheries: Finfish, and Shellfish.
What the analysis of the BCPI data, run through the band price filter, showed is that there have been four supercycles since the start of the 20th century. Those four cycles are shown in the graph in the lower half of the chart. The graph in the upper half of the chart shows the broad movement of four major commodities – oil, livestock, base minerals and agricultural products. Individually each commodity tends to be volatile, but all four tended to sync up at about the same time, creating the macro trend of a supercycle.
The four supercycles the economists identified were:
1899-1932: The first cycle coincides with the industrialization of the United States in the late 19th century.
1933-1961: The second began with the onset of global rearmament before the Second World War in the 1930s.
1962-1995: The third began with the reindustrialization of Europe and Japan in the late 1950s and early 1960s.
1996 – Present: The fourth began in the mid to late 1990s with the rapid industrialization of China.
If the next supercycle has begun, how will it compare or contrast with previous cycles? In Goldman’s view, this supercycle will be driven by the global recovery from Covid-19, and the push to revitalize economies based on a decarbonized energy system and with greater attention to social and economic inequities. To accomplish the growing policy prescriptions for net-zero emissions by 2050, there will need to be a massive capital spending boom. Although most people focus on growth of the electric vehicle industry as a driver for economic growth, building out a renewable fuels industry that could power the world will take massive numbers of wind turbines, solar panels, electric vehicles, heat pumps, and newly constructed or upgraded buildings. At the same time, we will be lifting hundreds of millions of people out of energy poverty.
Although fossil fuels may not be a prime beneficiary of this new supercycle, it will take massive amounts of other minerals, especially rare earth minerals. But until the infrastructure is built, and even afterwards, since the promoters of the renewables-based economy acknowledge that the infrastructure will need to be rebuilt in 15 years and then again 15 years later and so forth, many traditional energies and metals will benefit. The prescription for a renewables-based economy shows how you create jobs – build critical infrastructure that barely lasts long-enough before it needs to be rebuilt again. All this building will require oil and gas, although to a lesser degree in later rebuilding efforts than in the initial one underway now.
Exhibit 24. How Commodities Have Trended SOURCE: S&P Global Platts
An assessment of commodity price trends in 2021 by S&P Global Platts calls for oil and copper to be higher by the end of the year than at the start. They believe LNG and iron ore may be lower in price, but still meaningfully higher than at their low points in the spring of 2020. A key ingredient for their forecast is an expectation that the inverse relationship between the value of the U.S. dollar and commodities (graph in upper right of chart) will continue in 2021. That view is tied to the continued economic stimulus injected into the U.S. economy by Congress and the Federal Reserve Bank. A falling dollar makes commodities cheaper for foreign buyers who will use more, boost demand and prices. Of course, foreign countries are also benefiting from government and banking stimulus.
Another measure of what a weaker U.S. dollar means for stocks is the inverse relationship with the Emerging Markets Index. A weaker dollar boosts the economic growth of emerging economies. In the accompanying chart, we see the MSCI Emerging Markets Index compared to the ratio of that index to the S&P 500 Index. What the chart shows is the parallel track of the two measures from 2002 through 2012, after which the Emerging Markets Index under-performed the S&P 500 Index. Given the recent extreme divergence in performance, one should not be surprised if there wasn’t a reversal to the mean that brings the two measures back together. While it is possible the reversion could come about from a collapse in the overall stock market, the odds favor better performance for emerging markets, especially given the falling U.S. dollar value.
Exhibit 25. Are Emerging Markets Poised For A Rebound? SOURCE: Bloomberg
While economies often do not perform as anticipated, and stock markets can be very fickle, the weight of the economic and financial evidence suggests energy may be about to enjoy a few years of much better performance than experienced over the past handful of years. It can’t come soon enough for most of us.