Wait raw materials ‘super cycle’ after lost decade?
The sharp rise in the price of raw materials heralds a new ‘super cycle’, according to a growing chorus of market watchers. Thanks to the stimulus to the economy and the associated inflation concerns. How sustainable is the boost?
The miner Rio Tinto
this week came out with a record dividend, and that for a company that has already had 148 years on the counter. The British-Australian group has paid out no less than $ 9 billion to its shareholders over the past financial year. 2020 was a peak year for iron ore, the main raw material for Rio Tinto. Iron ore prices soared 85 percent to its highest level in nine years, thanks to robust demand from Chinese steel furnaces.
China’s renewed resource hunger, which recovered relatively quickly from the corona diecast, is fueling countless other commodity prices. Soybeans have become over 50 percent more expensive in the past year and are at their highest level in six years. The copper price is at its highest level in eight years. And oil, which was worth nothing last year, again costs more than $ 60 a barrel. According to stock exchange JPMorgan Chase, the oil price could rise to $ 100.
No wonder the commodity price boom has reopened the debate about a new ‘super cycle’. In such a cycle – which occurs every few decades – the prices of all kinds of raw materials are structurally higher, typically because the demand exceeds the supply. There have been four super cycles in the past 120 years (see graph), with the most recent peaking in July 2008 after a 12-year expansion. China was the driving force at the time through its rapid industrialization and urbanization, which unleashed a rush for raw materials.
In the meantime, we are at the beginning of a new super cycle, fair houses insure. Goldman Sachs sees the pandemic as a “structural catalyst” for a super cycle, while JPMorgan plainly states that the “revival, especially for oil, has begun.” The Citi analysts are more nuanced: copper and aluminum have a chance of a super cycle, oil much less.
Not every raw material therefore has a bonanza, although there is little to notice for the time being. A basket of 27 different commodities only increased in the six months to mid-January, a synchronous upturn that has never occurred in the past 50 years, according to SummerHaven, an asset manager specializing in commodities. And certainly not in the lost decade since the peak of 2008, when commodities fell out of favor with investors.
For the current turnaround, analysts point to the expected significant economic recovery once corona vaccines are rolled out widely and massive government stimulus takes hold. The promised infrastructure investments – including those in a green transition – consume a lot of raw materials. In addition, some production chains are still disrupted by the corona virus, which gives prices such as those of copper, iron ore and cobalt an extra boost. At the same time, the low commodity prices of recent years have slowed down investment by the miners, exacerbating capacity shortages.
If you look at the past 150 years, stocks and commodities have comparable returns. Only investors have forgotten that.
Commodities are also benefiting from growing inflation fears from the massive stimulus and an overheating economy. In the past they have proven to be a good inflation hedge for investors. Commodity prices typically rise with the general price level in an economy.
Warren Patterson, raw materials strategist at ING, says it is still ‘premature’ to talk about a new super cycle. ‘China is recovering from the pandemic and imports all kinds of raw materials, but the question is how sustainable that is. If the Chinese government continues to stimulate, you can expect strong demand for raw materials for another two years, but the risk of the economy overheating is growing. ‘ There are already signs that China is scaling back stimulus measures. ‘It is therefore important that other countries participate, such as India. China then acts as a detonator for a new super cycle, ‘says Patterson.
If the Chinese government continues to stimulate, you can expect strong demand for raw materials for another two years, but the risk of the economy overheating is growing.
We then look to the US, where President Joe Biden’s administration wants to unleash an additional $ 1,900 billion stimulus package on the economy and where the Fed, the central bank, has opened the liquidity tap. The ultra-flexible policy of the central banks, which allows governments to borrow cheaply, is the main driving force behind a super cycle, according to Chris Watling, founder of the London research firm Longview Economics.
“The Fed and the dollar are decisive, with the Fed signaling that it wants to pursue a flexible policy for a long time to come and the declined dollar boosting commodities,” says Watling. The latter is because commodities are typically traded in dollars, making them cheaper for non-dollar countries. Watling points out that for an investor, commodities today are very cheap compared to equities and that they provide an excellent hedge against inflation.
Commodities as hedging
For SummerHaven, the rising inflation expectations of the market are currently the strongest argument for an investment in commodities. “Investment portfolios today are not positioned for an increase in inflation for the simple reason that inflation has not been a concern for the past decade,” said Kurt Nelson, founder of SummerHaven. The rise in long-term interest rates in recent weeks indicates that investors are gradually becoming aware of a possible inflation surge.
Investment portfolios today are not positioned for a rise in inflation for the simple reason that inflation has not been a concern for the past decade.
Commodities provide the ideal hedge, says Nelson. Their returns can be compared to equities in the long run. ‘If you look at the past 150 years, equities and commodities have comparable returns. But investors have forgotten that because commodities have underperformed and equities have been in a long rally. ‘
His colleague Geert Rouwenhorst, head of research at SummerHaven and professor at Yale, puts the concept of a super cycle into perspective. ‘That is a theory with only four data points (the past four super cycles, ed.) That is descriptive rather than predictive. Afterwards you can always see a wave in the data. In addition, the explanation is different for each cycle. We know more about economic cycles, which I prefer to focus on. They learn that the second half of an economic expansion is typically better for commodities, while equities do better in the beginning. ‘
Assuming we are at the beginning of a new economic cycle, that would mean it is too early for commodities. ‘That is why the inflation argument for commodities is currently stronger than the argument for the economic cycle,’ says Rouwenhorst. Although he notes that the price of copper, an industrial metal that is sensitive to the economic cycle, has already risen considerably.
A green investment wave means a boost for battery materials such as copper, aluminum, nickel and cobalt.
The question is whether all resources will be a winner. Watling points out that some raw materials will outperform others at some stage. Patterson believes strongly in oil for the next two years due to the economic recovery and recent underinvestment in capacity. Afterwards, the oil price threatens to come under pressure as a result of the green transition that governments are aiming for. A green investment wave means a boost for battery materials such as copper, aluminum, nickel and cobalt.
Because it is difficult to predict the exact winners, SummerHaven recommends an investment in the broad commodities market, which can be done via a tracker. Investing in a mining stock such as Rio Tinto is also possible, but according to SummerHaven comes with management risks that are independent of the pure commodity price.