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China dents hopes of a new era of prosperity for commodities

2 Sep 2021

The anticipated commodity supercycle could be turning into a supercrash, finds Andrew Holt. Not long ago, there was a lot of talk about a commodity supercycle. It was happening, if it had not already arrived.

Data like the Bloomberg Commodity index reached levels not seen since 2015 with commodities being the strongest performing asset class in the first half of 2021. It all pointed to one outcome: a commodity supercycle.

But a few months later, the picture is very different. Price rises have run out of steam and many – including copper, often thought of as the foundation of economic growth – have fallen in recent months.In fact, things have shifted completely, and to such an extent that some commentators have started talking about a commodity supercrash.

The problem stems from, as with most financial issues today, China. Its economic outlook is vital to commodity markets. And here is the problem: growth in the country is slowing. The World Bank estimates that China’s economic growth will fall to 5.4% in 2022, down from 8.5% this year.

And with this, commodity demand is sinking, taking the steam out of prices for rhodium, palladium, oil and copper. Also, the supposed commodity supercycle of today is different to previous periods of high demand for natural resources.

Structural shift

For a commodity cycle to become truly super, there has to be a structural shift in demand that keeps prices climbing for years. Supercycles can take from 20 to 70 years from peak to peak, hence the excitement when they seem to appear. The long swings are caused by insufficient investment in capacity resulting in the booms, when they come, being spaced out.

During the supercycle in the 2000s, China’s rapid growth – during which annual economic growth at times exceeded 10% per annum – caught the world’s supply of commodities short and spurred a longer period of price growth as producers struggled to keep up. Investors had their eyes on China and the commodities it was sucking up, as it cemented itself as the workshop of the world.

Although, it is generally accepted that this time is different. Many observers saw the transition to green energy as a catalyst for another supercycle. Here it was a simple assessment that roads, bridges, rail links, solar parks and wind farms need in- dustrial commodities, along with precious metals like silver.

Combined with massive government stimulus packages to invest in infrastructure, as well as renewed post-pandemic demand, hopes were high that we were entering a new age for commodities, if not a supercycle. All that, of course, now looks less certain with China taking centre stage again.

China still counts for more than half of international demand for commodities, so its role in the global commodity market is crucial and simply too big to not be part of the overall story.

Moving in cycles

Supercycle advocates claim the commodities rally is not over. They point to the green energy transition, which will only gather momentum, and demand will be there so long as countries’ re-openings are not derailed by Covid variants.

In addition, some of the uncertainties of the market are anomalies of commodities. They move in cycles because sporadic surges in demand cannot immediately be met by increases in supply. This imbalance leads to high prices and wide profit margins, which pushes capital spending higher, leading to big additions of supply.

Supercycle sceptics point to all, or at least most, roads leading to a commodity supercrash. They stress a sound point that the recent Covid price spike was based on a temporary demand that was delivered around the stimulus and Covid limitations to supply. Both are now disappearing – and at different paces for different commodities.

In addition, coming back to China, the post-pandemic recovery has been poor in the world’s second largest economy. And moves around tightening monetary policy have worried markets, while fears over variants and prolonged restrictions have added concerns. None of which is good news for commodities.

But if a commodity crash is underway, it could have bigger implications than whether to invest in natural resources or not. In the worse-case scenario, it has been suggested it will deliver a deflationary shock – and it could indeed be of such force, that the Fed will step back from a taper and China towards a harder asset stimulus.

If, and possibly when, this happens, will depend upon how quickly falling commodity prices flow into junk debt, emerging markets, and, ultimately, developed economy equities via a ‘growth scare’.

All of which would be far away from anything ‘super’.

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