Commodity prices have surged to very high levels this year. Iron ore and copper prices hit all-time highs before falling back after Beijing moved to curb prices. Aluminium prices are elevated and oil prices are fluctuating at about $75 a barrel. So are we at the start of a new commodities supercycle?
Our view is that we are seeing a normal business cycle recovery in commodity prices, not a supercycle. Our definition of a supercycle follows that of Russian economist Nikolai Kondratieff — and his depiction of long-term trends that prevail over decades. In the context of commodity prices, a supercycle means an upswing in prices that lasts 10 to 35 years.
Supercycles are pretty special events. Over the past 150 years, there have been just four supercycles but there have been many more business cycles.
We believe commodity prices will come off their current peaks and remain elevated for some years. But we do not predict prices will be elevated for a decade, which is what is needed to be supercycle worthy.
All commodities are different but a common pattern at present is higher prices driven by strong demand and a lagged supply response.
On the demand side, we think commodity demand has disproportionately benefited from the nature of the Covid-19 recovery. Lockdowns and social-distancing restrictions led people to stay at home and spend more than they normally would on durable goods — washing machines, gym equipment, electronics, and new homes. This led durable goods spending to rise much faster that the pandemic trend. That demand has in turn fed through to commodities — steel, copper, iron ore and aluminium.
But this pace of durable demand will not endure. As lockdowns ease, we expect consumer demand to rotate away from goods to services — as people start going out to bars, restaurants, movies and on holiday. Purchases of durable goods will fall, and so too will the demand for raw materials.
What about various governments’ Covid-19 economic recovery plans through infrastructure investments? Demand from China has been exceptionally strong. But we are already seeing signs of easing, as China has shifted to a tightening phase of monetary and fiscal policy. The European Green Deal and Joe Biden’s American Jobs Plan, which folds in about $1tn on infrastructure spending, are no game changers. Our calculations show they will have only modest uplifts to metals demand growth.
On the supply side, sustainability and decarbonisation concerns have intensified. China’s ambition to limit its use of coal-fired power is real. They have led us to lower our forecasts of future commodity supply, particularly for aluminium and steel. It means we expect commodity prices to leave their current peaks, but then settle at a higher level than what we had forecast a year ago.
Take the case of copper. Mine output is performing better than expected but the pandemic remains a threat to copper’s perceived fragile supply side fundamentals. A wave of new capacity is expected to come on stream between 2021 and 2023. We expect the copper price to ease back from current levels in the next few years but to remain well above industry marginal costs.
There is a lack of committed copper investment from the middle of the decade and supply could lag demand and propel prices higher again. There are a number of projects that could meet the rising demand for copper from electrification and renewable energy. But with environmental concerns, mine complexity and political uncertainty, the required supply will only be viable at a higher price than copper has seen in much of its past.
Finally, on non-fundamental factors, inflation fears have driven a fair amount of speculative purchases of commodities and related stocks. Our view is that the rise in inflation is temporary, and we are not going back to the 1970s. As such, this speculative activity is somewhat misplaced and could give rise to a correction.
The supply and demand imbalance due to the economic recovery from the pandemic is likely to ease as economies open up and consumers shift their spending patterns. There is still uncertainty around government plans ahead of the UN climate conference COP26 and we may get new information that alters our assessment. Until then, this will remain a normal commodity price cycle. There is nothing super about it.
