The commodity supercycle: is a big drop coming?

The commodity supercycle: is a big drop coming?

Farmers might not know much about commodity supercycles.

Some might not believe in them.

But supercycles are real, and whether or not farmers believe in them, they believe in farmers, declares a convincing chorus of specialist economists.

“It’s not just a regular business cycle,” said economist Bilge Erten of Northeastern University in Boston, in an interview with The Western Producer. She and Columbia University economist Jose Antonio Ocampo co-authored an influential 2013 study of the commodity supercycle phenomenon for the United Nations Department of Economic and Social Affairs while she was employed there.

“These massive demand episodes surpass any supply that exists in the market.”

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Crop growers generally saw great gains during the current commodity supercycle, which in agriculture soared, peaked and turned between 2006 and 2013. Prices rose far above anything seen before the six-year boom.

Unfortunately for farmers, Erten has a grim prediction: The general weakening of commodity prices is likely to continue for “at least another decade…. There is likely to be more contraction going forward,” she said.

But she said farmers who understand supercycles and how to anticipate them might be able to make better investment decisions to better handle the periods of weakness and be prepared for the eventual return of higher prices.

Economists have recognized apparent cycles and patterns in economic growth and markets for more than a century. Most people who have studied economics know about Nikolai Kondratiev, the 1910s-20s Russian economist, and the 50-60 year economic waves he identified and are now named in his honour.

Even before his time, economists had been spotting and discussing various sorts of economic cycles, including those affecting commodities.

But it was only in the latter half of the 20th Century that “commodity supercycles” came to be carefully dissected and understood, at least by those economists who believed they existed.

They were little discussed outside academia until the early 2000s, with the term “commodity supercycle” scarcely heard outside of universities, until famous investor Jim Rogers popularized the notion in 2004 with his book Hot Commodities.

Rogers argued that the world entered a new commodity supercycle in about 1999 or 2000 and was probably on the cusp of seeing 15-20 years of much stronger commodity prices.

It was a novel concept with investors at the time, but as energy and metal prices soared in value, and agricultural commodities also belatedly took flight and stunned the world, people began commonly referring to “commodity bull markets” and “commodity supercycles.”

Early on there were skeptics, but most disappeared as commodity prices soared and repeatedly rallied from the mid-2000s to 2012.

Still today the term “commodities supercycle” pops up in research articles and newspaper stories, with investors keen to discover the next one and get in early. (See accompanying story.)

Erten said that among economists who study the area, the concept of the supercycle is now generally accepted as valid.

A commodity supercycle is a 30- to 40-year price cycle, timed from one bottom in prices to the next. Commodities go from having chronically low prices to seeing prices dramatically rise and peak at a level far higher than the trough from which they started. Then prices settle back down and eventually end up far beneath the peak and at a new bottom, which is the cradle from which the next supercycle grows.

Most economists who believe in commodity supercycles say they are driven by a powerful rising tide of global economic growth sucking in ever greater quantities of commodities. As the demand outstrips supply, prices of commodities surge and keep surging as long as the growth continues.

Since the economic growth begins when commodity supplies are plentiful, prices do not begin strongly rising for a number of years. Erten said the general lag between accelerating world growth and commodity prices is about six years.

Prices soar when supply cannot quickly keep up with surging demand because it takes years to dig new mines, build more smelters, clear more land for agriculture, and expand railways and shipping systems.

Eventually, when the demand growth weakens and supply production finally begins to catch up, the basis for high prices fades and commodity prices weaken.

Often long after the surge in demand has faded, new commodity supplies come to market as long-term development projects mature. This tends to maintain plentiful commodity supplies for years after prices have fallen, keeping prices low for a long time.

Erten believes the current supercycle (she sees it as still ongoing) began in 2000.

It was probably powered by booming growth in China, which added huge demand for most commodities, eating up surpluses and surpassing the ability of commodity producers to keep up. The first two commodity supercycles she has studied were also driven by the creation of major, growing new demand.

Canadians saw evidence of that boom in fresh demand in high oil prices enriching Alberta and Saskatchewan from the early 2000s until 2013, when prices went from less than U.S. $10 per barrel to $148 at the 2008 peak.

Farmers saw it in spring wheat futures that went from U.S. $3 per bushel to $22 in 2008.

And Canada generally boomed as everything from coal to gold to lumber surged in price for years.

Even the world financial crisis of 2008-09 didn’t kill the commodity supercycle. After a brief relapse into lower prices, commodities soared again until 2012.

Where do we go from here?

Previous supercycles, Erten argues, ran from the late 1890s to 1932, 1932 to 1971, 1971 to 1999, and the present cycle. The beginning and ending dates are approximations because prices at the trough tend to be part of a years-long stagnation.

Since the first two lasted 30 to 40 years, and this supercycle is “similar to the first two” in many aspects, Erten predicts a decade or more of weakening price support for commodities overall.

Erten said farmers can understand their likely economic situation better if they grasp the basics of the commodity supercycle and where we are inside it. There might be “little blips, fluctuations, a few years up, a few years down” in the next decade, but farmers should be prepared for overall weakness.

“If the historical supercycle (pattern) repeats… then it is likely to go on another eight to 10 years.”

They can also gain by knowing when to anticipate the next supercycle. Strong world economic growth for a number of years should be a good leading indicator.

“Deviations in global output from the long-term trend exactly predict these long term cycles in commodity prices,” she said.

Erten said people might see today’s economic recovery in the United States and Europe, and continued economic growth in China, as signs that another commodity supercycle could begin now.

But she stressed that growth itself is not enough; the growth must be strong and gaining momentum, which is currently not the case.

China, whose growth was probably the prime factor behind the 2000-onwards commodity supercycle, has fallen to about six percent per year.

“It will just not be enough to boost commodities demand as it was (when it was) growing at the double-digit level of the early 2000s,” she said.

That doesn’t mean there can’t be bull markets in various commodities, or for commodities overall, but those will probably be part of the normal business cycle and will fade when the business cycle, which is far shorter than a commodity supercycle, enters its weakening phase. Market players would describe that as equivalent to a bear market rally.

“I think it’s very premature to think that the next supercycle is here. For probably another decade it’s very unlikely we’ll see the next supercycle going forward,” said Erten “If we were to see it, it would be something very unusual.”

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