The benchmark commodity index, Reuters/Jefferies CRB Index (CRB – 299.10), has skyrocketed from the Apr 2020 pandemic low (101.48), gaining over 195%. WTI Crude Oil (WTIC – 109.27) has soared 17-fold from its Apr 2020 low (6.50), Wheat (1,101) has jumped 134%, and Copper (4.70) leaped 138% from their respective Mar/Apr 2020 bottoms. Commodities and commodity-based sectors continue to retain market leadership roles within the financial markets. Heated discussions regarding a commodity supercycle are heating up in Main Street and Wall Street.
Investors need to understand the long-term drivers and the intricate historical relationship of commodities to other asset classes. It is important not to get carried away by the headline news from Russia-Ukraine, China, and other geopolitical events since Commodities are notorious for sharp but fleeting boom cycles followed by abrupt and devasting bust cycles.
Historically, commodities tend to move in sympathy with each other. However, energy, agriculture, and metals can trade in isolation and sometimes inversely to commodity peers due to their dynamics and idiosyncratic.
What causes commodities supercycles?
The main driver of commodity supercycles is the industrialization and growth of a country. For example, America emerged as a world economic superpower at the turn of the 20th century, and China emerged as an economic power at the beginning of the 21st century. Both countries triggered extended periods of economic growth, rapid industrialization, and enormous demand for commodities.
However, commodity prices remaining elevated for an extended period can also involve supply constraints, either by internal (i.e., shortage of raw materials of demand) or external means (i.e., supply chain constraints aka the 2020 medical pandemic). Because there is a lag in supply throughout the supply chain, commodity prices will trade higher, sometimes much higher, until the supply and demand return to equilibrium or growth slows.
Four well-defined commodity supercycles have occurred since the mid-nineteenth century. Super cycles are decade-long rallies, typically well above the longer-term trends and in a wide range of raw materials and natural resources.
The first commodities supercycle began in the late 1890s, coinciding with the US economic growth expansion cycle. The building of factories and manufacturing facilities to meet consumer demands for finished products and the urbanization of cities ignited the commodities bull cycle. The entry of America into World War I also accelerated demand for raw materials and natural resources. The boom cycle peaked briefly around 1917 but then resumed until the early-1930s.
The second supercycle began in Europe around the start of World War II. As the conflict deepened, it would soon encompass almost the entire world. The strong demand for resources and raw materials for the war efforts and the extensive reconstruction of Europe and Japan post-war led to the commodity supercycle. Although the commodity supercycle peaked in the early-1950s, the demand did not fade until many years after the post-war growth cycle ended.
In the 1970s, we witnessed the third commodities supercycle. It started with strong global economic growth from developed, developing, and emerging countries. Commodities (i.e., crude oil) surged dramatically soon after the OPEC oil embargo (external shock). Natural resources and materials continued with their boom cycle until the early-1980s. Key commodity prices exploded to unsustainable speculative levels, ending with the bursting of the commodities bubble.
In early-2000, China joined the World Trade Organization (WTO). The fourth commodities supercycle began with the mass migration of workers to cities. The surge in housing coupled with modernization and industrialization further fueled explosive growth. China quickly became the top consumer of natural resources and raw materials worldwide. The commodities boom cycle was briefly interrupted by the 2008 global financial crisis and the 2020 pandemic. However, the ensuing response by the US, China, and central banks via monetary and fiscal stimulus programs led to the resumption of the commodities boom cycle.
Today, global economies may be emerging from the 2020 Covid-19 pandemic, with many expecting the pandemic to move to an endemic phase. Russia/Ukraine debacle and the continuation of the supply chain bottlenecks have also led to inflation soaring to decade high and commodities prices retesting their prior all-time highs.
Investors are now trying to determine if this is the start of a new commodities supercycle or a cyclical bull commodities phase.
While the above are positive for commodities, is it sufficient to keep commodity prices trending higher and elevated for decades?
Evidence strongly suggests industrialization is one of the influential drivers of commodities supercycles. Typically, it begins as a cyclical bull cycle but turns into a commodities supercycle when the structural forces take over.
Today we have the following developments: The electrification of the global economy. Decarbonization and a shift away from carbon-based fossil fuel. The proliferation of the green infrastructure. Rising global population and increasing demand for raw materials and other commodities from developing/emerging countries. Continued urbanization in the world. Higher living standards from countries including China, India, and other countries.
It is not necessarily investors like commodities. But a simple response from investors needing to hedge risk in an inflationary environment. Only time will tell if this is indeed the next supercycle.