Commodity supercycle or short-term squeeze?
The bulls are proclaiming we’re in the early stage of a new commodity supercycle, but more cautious observers warn the run-up in commodity prices reflect temporary disruptions to supply.
Commodity markets have been on fire this year, as the combination of ultra-low interest rates and hopes for a speedy roll-out of vaccines across the world’s largest economies have left investors to bet on a rapid rebound in global industrial activity.
The price of copper – often called “Dr Copper” for its uncanny ability to predict where the global economy is heading – this week climbed above $US9000 ($11,370) a tonne for the first time since 2011, continuing the surge that has seen it gain 15 per cent so far this year.
Nickel, meanwhile, has climbed above $US20,000 a tonne for the first time since 2014, while spot iron ore prices are trading slightly above $175 a tonne, and close to a 10-year high.
Meanwhile, investors are turning to the precious metals as a hedge against rising inflation. Last August, the gold price rose above $US2000 an ounce for the first time, although it has since eased back,while platinum prices are nearing their highest level in six years.
The spectacular surge in commodity prices has prompted some to speculate that we’re in the early stages of a new commodity supercycle – long broadly based bull markets in commodities, similar to the one that stretched from the late 1990s until the early 2010s.
This is likely to put downward pressure on the US dollar, which reduces the price of commodities denominated in US dollars and helps bolster demand.
At the same time, fears that the Fed’s policy will kindle inflation have spurred renewed interest in commodities as a way to hedge against future price rises.
This week, the yield on US 10-year bonds rose to its highest level in a year as investors worried that a strong economic rebound, driven by more debt-financed US government spending, would stir inflation.
Commodity bulls also point out that the response of the world’s major economies to boost spending in the wake of a pandemic is likely to be reflected in a synchronised global rebound, which will set the stage for a commodity supercycle.
But sceptics contend that the bulls are overstating their case.
They argue that China – which is the main driver of demand for mining commodities, accounting for between 50 per cent to 60 per cent of global iron ore and base metal demand – is likely to prove out of step with the rest of the world.
Stimulus won’t be repeated
Last year, China exhibited a voracious appetite for commodity imports such as iron ore and copper as it boosted infrastructure investment in the wake of the pandemic.
One of the drivers of China’s economic recovery was a massive 6 trillion yuan ($1.2 trillion) stimulus package, the equivalent of around 6 per cent of the country’s GDP.
Much of this flowed into the construction sector, helping China’s industrial output – a good indicator of commodity demand – to quickly return to pre-COVID-19 levels.
But analysts warn that stimulus on this scale won’t be repeated. And that means that China’s commodity demand will likely start to wane in the second half of this year, as the impetus from China’s infrastructure-centred 2020 stimulus starts to fade.
What’s more, China’s rapid economic rebound last year was also powered by a hefty increase in property investment.
Beijing, however, is clearly worried by the spike in property prices, particularly in the country’s mega cities, and has already introduced policy measures designed to curb over-investment and the build-up of excessive credit risk in the property sector.
Critics also point out that the commodity bulls overstate the magnitude of the rebound in industrial output that we’re likely to see.
Certainly, they concede that India’s robust demand for commodities will likely strengthen further this year, given that the country’s 2021-22 budget emphasises increased infrastructure spending.
But they point out that much of the rebound in industrial output – which drives commodity demand – has already occurred.
For instance, European industrial output is broadly in line with pre-pandemic levels, while industrial output in the United States is nearing its pre-pandemic level.
Instead, sceptics argue that the steep rise in many commodity prices reflects short-term supply disruptions.
For instance, although demand for copper is expected to rise because of the increasing popularity of electric and hybrid vehicles, this is only likely to boost global copper consumption by a few percentage points.
Instead, they believe that the latest spike in copper prices reflects fears that politically driven protests in Peru could disrupt the supply of copper concentrate.
Similarly, they point out that shipments from Brazil – the second biggest exporter of iron ore after Australia – have yet to recover from past waste dam collapses and pandemic-related disruptions to port and rail facilities.
Sceptics argue that we’re unlikely to witness a repeat of the extraordinary commodity supercycle that occurred in the first decade of the 21st century because that was driven by an unparalleled event – China’s transformation as a result of industrial development and urbanisation.
Unlike the adherents to the commodity supercycle thesis, they see the run-up in the prices of copper, nickel and platinum as simply an extension of the “everything rally” which has also witnessed an eye-watering rise in the price of digital currency bitcoin.
But that means that commodity price surges can quickly reverse if speculative investors decide to pull back, or if supply disruptions get resolved.