Explained | Commodities prices on fire – cycle or a supercycle?

Soaring commodity prices have sparked a debate on whether the world is entering another ‘supercycle’, or an extended phase of abnormally high prices that lasts at least a decade. Such a development can significantly change the pattern of global economic growth with a massive flow of funds into resource-rich countries, which will make a lot of money at the cost of importers. It can also raise inflation and hurt corporate earnings with higher input costs.

But is the world really heading towards a sustained commodities bull run? Experts are divided. In January, 2021, Goldman Sachs declared the dawn of a new commodities supercycle. Four months later, experts and audience polled at an online metals seminar said no new supercycle was in sight.

There are strong pointers in both directions and the outlook varies for various commodities. Moneycontrol examines the issue.

What is a commodities supercycle?

In a supercycle, prices rise sharply and remain elevated for at least a decade, usually because of transformational changes such as large-scale industrialisation or infrastructure building in major economies. We have previously seen it happen in the US in the late 19^th and early 20^th centuries, during the reconstruction of Europe and Japan after the Second World War, and more recently, at the turn of the century because of rapid economic growth in China and expectations of a demand surge in large emerging markets such as India and Brazil.

How are commodity prices behaving now?

Commodities prices and shares of companies in the sector are soaring. Prices of iron ore, steel, copper, nickel, crude oil, cobalt, zinc, wheat, corn, soybean, cotton and several others have risen sharply in the past year. Shares of some metal producers such as Hindustan Copper rose as much as seven times in the year to June 2020. Many other companies in the metals sector posted spectacular gains, significantly outperforming the broader market. Crude oil, which had fallen below $20 last year, the lowest in almost two decades, soared above $71 on June 3, 2021.

Why are commodities prices rising?

There are some broad reasons which apply to most commodities.

First, prices have bounced back from artificially low levels they touched in the first wave of the pandemic last year. The lockdowns had created supply bottlenecks and disrupted mining operations, which created scarcity and raised prices. This obviously has nothing to do with a supercycle.

Second, several countries including the US and India are stepping up infrastructure spending to catalyse economic growth. This boosts demand for natural resources as trillions of dollars would be spent globally to build roads, factories, airports and bridges. This again boosts demand but perhaps not for a very long period.

Third, stimulus packages, low interest rates and welfare schemes that provide cash to people tend to boost demand for natural resources. Many countries are taking such steps, which analysts say increase demand for food, construction, and metals.

Fourth, the weakening of the US dollar has an impact on commodity prices, which are usually priced in the US currency. When the dollar depreciates, producers in other countries need to increase prices so that their revenue in the local currency does not fall.

Fifth, good progress of vaccination against COVID-19, particularly in the world’s biggest economies, has raised hopes that economic growth will revive, which will boost overall demand. China has been a big buyer of commodities after it controlled the spread of the disease.

These factors may not drive up commodity prices for such a long period that it becomes a supercycle. However, there is another factor that can lead to a sustained rise in commodity prices.

Companies have not invested enough in exploration and production of several metals, particularly copper. The last supercycle that began at the turn of the century, was disrupted by the financial crisis and ended in a bust for commodities. Many companies around the world preferred to raise dividends at the cost of capex needed to find new mines.

Are there transformational changes that can trigger a supper cycle?

Yes. There is a green industrial revolution on the horizon, which will multiply the demand for some commodities, not all. The world is taking firm steps to reduce the use of fossil fuels and move towards net-zero emissions. This requires extensive use of wind and solar energy along with e-vehicles that will replace the ones fired by petrol or diesel. The market is already betting on e-vehicles dominating the automotive space. Last year, Tesla’s market value rose above Toyota even though the Elon Musk-led company’s sales are a fraction of the Japanese giant’s.

This transformation will require heavy use of copper, nickel and lithium, which are used in electric vehicles, batteries and other equipment. Solar panels need loads of copper, silicon, zinc and silver. Experts say that an electric vehicle needs about 80 kg of copper, four times the requirement of a conventional car.

All expert agree that copper is headed for a prolonged bull run in the decades ahead. Copper is a major ingredient in electric equipment. Some analysts have projected copper prices to rise 600 percent in the next decade.

There is of course a contrarian view for copper also. Experts say that electrical equipment and electronics are not the biggest consumers of copper in many countries. In the US, this sector absorbs 23 percent of the copper consumed in the country. Buildings and construction have a bigger share of 43 percent. So, copper demand from electric equipment alone may not ignite the market. However, by all accounts, demand for copper from electricals and electronics is poised to rise in multiples.

What about the China factor?

China, with is bulging economic muscle and voracious appetite for commodities, is the biggest, and perhaps the most unpredictable variable in the commodities equation.

“A few words from the Chinese government can go a long way. A one-sentence statement on May 23 promised ‘zero tolerance’ for ‘abnormal transactions and malicious speculation’ in commodities markets. The local price of iron ore and steel promptly tanked by 7 percent,” according to a report.

What is the outlook for major commodities?

Steel has already lost some shine, again because of developments in China. Prices have fallen in the past two months and Credit Suisse downgraded the steel sector on May 26. It said the sector remains vulnerable to risks such as a crackdown on prices in China. Moreover, easing supply chain shocks, and weak demand in China amidst strong production are other risks, the brokerage added.

Agricultural commodities: Food prices are also rising. In May, world food prices rose at their fastest pace since September 2011, the Food and Agriculture Organization of the UN said on June 3, 2021.

Cooking oil prices are rising sharply. Prices of edible oils such as mustard, vanaspati, soya, palm, sunflower, and groundnut are at their highest in a decade. This is a worry as India imports about 65 percent of its requirement. But this is unlikely to continue for long because poor weather in major supplying regions is a major factor for the spike. Soybean oil prices are rising because of dry weather in Argentina, the largest exporter, while sunflower oil’s price is up because of drought-like conditions in Ukraine and Russia, the largest producers and exporters of the commodity. Analysts expect the situation to improve with better weather in the next season. Soybean and corn have risen to the highest levels in many years, driven by Chinese imports.

Oil prices have risen sharply in recent weeks to the highest in more than a year but the long-term outlook is bearish. The International Energy Agency, the energy watchdog for the developed world, recently made a startling declaration that if the world seriously moves towards net-zero emission in 2050, then there is no need for any new oilfield apart from those already being developed. Oil prices have risen sharply this year, but this is more because oil cartel OPEC and Russia have squeezed supplies, particularly after prices sank below $20 last year. But if oil prices remain high, production from US shale deposits becomes viable.