200 years of history says commodity cycle can’t last

It’s an under statement to say that Australia’s fortunes are inextricably linked to the Chinese economy. China has become our largest export destination, with its export share having grown from around 5% in 2000 to 22% in 2009 (see below IMF chart):

No other commodity exporter has benefited as much from the China boom than Australia, as shown by the below IMF chart. Australia’s terms of trade (ToT) has literally exploded since 2003 as China drove-up the price of iron ore and coal – Australia’s two major exports.

Now Australia’s ToT are sitting at 60-year highs, which has significantly raised national income, increased the Government’s tax take, and sent the Australian dollar to near parity with the USA. Readers seeking a detailed analysis of the impact of the ToT on Australia’s economy are advised to read Tom Conley’s excellent recent article on this issue.

Finally, the surge of the ToT has led to a significant increase in mining investment, as mining companies look to build supply capacity (see below RBNZ chart). This investment, in turn, has significantly boosted Australia’s GDP.

The question is, how long can the commodity boom last? Whilst the Reserve Bank and IMF (see second chart) are predicting that Australia’s ToT will remain at elevated levels for an extended period, notable investors like Jim Chanos, Vitaliy Katenelson, Gary Shilling, and Puru Saxeena have warned that the Chinese economy is a bubble about to burst, and are forecasting a sharp slowdown in Chinese growth and a collapse in commodities prices sometime in the near future.

Adding to the bear case is the below chart from Macleans.ca, which tracks the 10-year annual returns in overall commodities over the past 200 years (h/t Financial Insights). The chart shows that every time that commodities prices have risen as fast and as high as they have over the past decade, a sharp decline has followed.

While it’s possible that this commodities cycle will continue to defy gravity for an extended period, the weight of 200 years of history is against it. If a contraction in China’s economy doesn’t send commodities prices crashing down, then a flood of new supply from competing commodities producers will force prices lower (albeit more gradually).

The worst case scenario for Australia is if plummeting demand from China is met with rising supply as the massive mining investment currently underway in Australia, Brazil and other commodities producing countries begins to bare fruit.

For what it’s worth, I am siding with the bears on this one. Commodity prices will not defy gravity and will most likely decline almost as fast as they rose. 200 years of history and basic economics is too much to ignore.

Cheers Leith

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Unconventional Economist


  1. In the last 200 years when has the supply of money expanded at such a rate?

    If we dont see deflation we wont see commodities contract since they’re all priced in monopoly money.

    • Juk – deflation is just around the corner, all Western Governments know it, printing money is a short term measure, we have 10 plus years of contraction in the western world ahead of us (due to the introduction of the pill in 1962 – which very few people seem to see/get).

      Leith – you really should spell this out in a future post, overlay immigration adjusted birth indexes with spending cycles – a reasonably accurate prediction of GDP forward projected.

      The birth rate went backwards from 1962 to 1975 (X Gen) – this generation will not spend the same dough as the baby boomers before them – the gap on the graph is MASSIVE, email me and I can send you a couple of slides to illustrate the hole.


  2. The reliance on selling off the farm is not a new scenario.Both sides of politics are caught up in that conventional “wisdom” and have been for many years.

    As you say,Leith,it can’t continue.When that penny finally drops in the halls of power (after the event) we are all left with the task of cleaning up the mess.

  3. Great article Leith (and not just because of the plug!! But thank you)

    I’ll be using that graph from Macleans, it’s a cracker. No doubt we’re in for some interesting times over the next year or so. Have you seen this from the RBA (http://www.rba.gov.au/publications/bulletin/2009/jan/pdf/bu-0109-1.pdf), it’s a from a while ago but provides some very interesting figures on production, consumption, supply and exports and imports of bulk commodities. (See Table 2 especially).

  4. Interesting eh? Getting a picture of the dynmamics at work. I get this sense that all us boomers need a garage sale. We certainly dont need any more “stuff” and we are all living in the biggest house we will ever live in from now on. Some of us have 2 plus a caravan etc. I remember as a kid (born 1945) we seemed to be educated on perpetual building sites or schools that were half made up of transportables. There were always heaps more kids in the next years behind me, and twice as many in 1st year at University when I was in 3rd. Within a few years of us wanting houses the building Societies ramped up and with loans on 10% deposit vs the banks 40% and we all went for it and built “massive” 150 m2 homes (now days 250m2) Not long after that they had doubled in price, proving that you should borrow to the max. Half my cohort had the first kid and the marriage in the same year, by age 24. 1962 (the pill ) was when we just finished high school… it took a few years to be normalised enough for single girls to go ask for it 🙂 But from there on everyone had a choice about it. Had not realised the next mob , X was such a big drop. Demographics matters.

    • “Warren Buffet is gearing up BNSF to deliver coal to the West Coast.” His coal trains have been coming through my town in Montana for years. Nothing new. It’s a one track line so you can’t increase capacity. The coal comes from the Powder River Basin and unit trains are maxed out coming out of there. Only question is where you send the coal. In essence, so what.