Are we in the early stages of a commodities super-cycle?
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Booming demand for commodities can be an indicator
We are currently observing record prices for a range of commodities, including the all-important iron ore price. Copper has also seen a strong performance in the past year and, with cereal and dairy prices continue to be firm.
There has been a lot of talk recently among market commentators that there could be a commodity super-cycle brewing. An extended period of booming demand for a wide array of commodities, leading to a surge in their prices, which could suggest we are in the early phase of a multi-year or multi-decade up-trend.
Looking back, there have been only four commodity super-cycles over the past 130 years. The most famous one was arguably not even a real super-cycle, driven as it was by a concerted effort by oil producing nations to restrict supply in the 1970s, taking oil prices significantly higher.
We look for big, sustainable changes in demand as the fundamental driver of super-cycles. However, you can still have prolonged periods of strong commodity pricing from a robust economic expansion (cyclical growth phase) without there being an actual super-cycle.
Chinese demand was the driver of the most recent super-cycle. Its enormous and fast-growing appetite for raw materials drove the longest period of sustained fixed-asset investment we can find. After super-charging this investment cycle during the global financial crisis, China eventually took its foot off the gas in an effort to balance its economy towards more sustainable industries and to reduce leverage in its financial system.
There are a lot of macroeconomic factors to suggest commodities are well supported at the moment. For instance, robust Chinese demand from construction and infrastructure building, large fiscal stimulus packages around the world, and expansionary monetary policies are all supporting demand. These factors are providing the backbone for a synchronised post-Covid global recovery that is likely to see global growth accelerate and create demand-growth for commodities that do not rely entirely on China.
In Australia, iron ore is the biggest commodity affected by this global recovery. While China is, and has been, critically important for iron ore demand, it is highly likely the rest of the world will consume more iron ore in the next couple of years than they have in a long time as infrastructure developments and fiscal spending require steel inputs.
Large Australian miners operating close to capacity
Iron ore is currently trading at record levels, around US$190/tonne, and most analysts have been calling the end of this rally since it traded at US$120/tonne. The large Australian miners (BHP, Rio Tinto, Fortescue) are operating at close to capacity. Vale, the other large global supplier from Brazil, has ramped production towards the top of its current capacity in recent weeks, despite battling Covid and mine closures on safety concerns.
It is no easy feat to increase iron ore production meaningfully from here. There are some miners bringing new capacity to the market in the next few years, but it takes a long time to develop a mine. China is the most likely responder to the high iron ore price as it has significant iron ore resources and many mines are currently idle. However, we still have not seen much of this supply hitting the market and the iron ore price keeps creeping up.
Whether this is a super-cycle developing or a strong business cycle fuelled by a global recovery can be debated; Harbour Asset leans towards the latter. However, we are acutely aware of the green economy agenda that has been fostering for years. This has been gaining momentum on the back of both the US administration’s focus on clean energy as well as China’s recent actions of choosing to close down productive capacity in ‘dirty’ industries to better care for its people.
Typical applications of the commodities of the future include electric vehicles, energy storage, wind turbines, and solar PV. The most commonly considered commodities to fuel the energy transition to a lower-carbon world are the likes of lithium, cobalt and graphite. However, copper, nickel, silver and a whole lot of other materials are also critically important. Many of these will benefit from the large volume or resources that will be required, some will benefit from being genuinely scarce, while others are likely to become redundant as future technologies change the required materials mix.
Advocates of a cleaner, less emission-intense future will view it as a multi-decade thematic that will drive consumer behaviour and government policy settings for the long term. This will likely drive a structural change in commodity requirements and some commodities will disproportionately benefit. This presents multiple opportunities for investors to gain exposure and allocate capital to what has many of the ingredients required for a commodity super-cycle.
Investment managers can aim for diversified portfolios, with exposures to both cyclically well-placed materials, as well as [hopefully] the winners of future commodity demand. Many of these exposures can be highly volatile and, through appropriately sized positions, a long time horizon, diversified portfolios, and good access to industry insights, managers can digest the riskier nature of these investments with an aim of contributing to the future capital growth of clients.
Source: Øyvinn Rimer is a director and senior research analyst at Harbour Asset Management.
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