Citi weighs in on commodity super cycle debate

Citi has joined the recent debate about whether the commodity super cycle is finished (or nearly so) with an argument in the affirmative. Bulls like to point to the fact that the apparent intensity of use for steel (in terms of kg per capita) for China is still well below some other countries at their peak. However, Citi reckons that in terms of “value in use”, China is already above most of the developed world.  In other words, while consumption of commodities in terms of volume still lags behind many countries, the value of the commodities China is consuming has already been higher than most countries:

The structural story — The bulls on the sector point to intensity of use charts for commodities on a kg/capita basis and extrapolate this into the future.  This ignores one vital component which is price, as it assumes that developing economies will continue to consume ever increasing quantities of commodities regardless of the price.  If we look at value in use rather than intensity of use this changes the argument and suggests China has already overtaken most of the developed world.  Arguably for commodity consumption to increase globally then prices need to come down.

Margins have peaked — Mining margins peaked around 2007 and since then the industry has faced higher depreciation costs, higher operating costs, higher oil prices, higher exchange rates, higher capex costs and higher salaries – all these factors are continuing and margins will continue to come under pressure.

Returns have peaked —On an EVA basis (ROIC – WACC) the peak returns for the sector occurred in 2006, yet earnings momentum peaked two years later in 2008 and has subsequently moved higher.  In our view the mining sector bought earnings momentum through M&A, and the mining sector is now buying earnings momentum through unprecedented capex spend.  Importantly ROIIC is falling.

And arguably, China’s investment boom in the recent years have been getting less and less efficient:

Arguably the investment boom in China is already becoming less efficient due to higher input costs.  In the past decade, China’s GDP grew at an average rate of 10.5%. Investment expanded at an average rate of 13.5% during the period, the main contributor of growth. As a result, share of investment in GDP increased from 36.5% in 2001 to 48.5% in 2010.

The efficiency of investment appears to be falling – In the absence of a more reliable metric for assessing the productivity of investment, we employ the Incremental Capital Output Ratio (ICOR) as an indicator of marginal product of investment. During 2001-2010, China’s average ICOR topped 4. More recently, the ratio rose to around 5, with a big jump in investment/GDP ratio—associated with stimulus measures introduced to tackle the global financial crisis—producing a relatively small output response.

ICOR is obtained by dividing the ratio of investment to GDP with real economic growth. The ratio shows the amount of capital investment incurred per extra unit of output. The higher the ratio, the lower the productivity of capital.


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  1. interested partyMEMBER

    Japan and Korea had far more favourable economic environments (Globally) to reach the vol per cap limits where China is battling severe economic headwinds, so to extrapolate past trends into the future seems wrong to me. Putting the growth environments alongside price will/ should give you a better insight as to where price/vols are headed in the short term.
    Little surprise really that PMI’s are missing to the downside.
    Add in the peak “cheap oil” outlook.
    I for one cannot see upside in the resources sector for the foreseeable future. And I contract within the sector. It is a little disconcerting, to put it mildly.

  2. I for one cannot see upside in the resources sector for the foreseeable future.

    So why are the big miners investing like crazy?

    • interested partyMEMBER

      My view point is coloured by the debt levels globally, which will take years to clear if at all. I also see the big miners as “human” meaning that everything they do is not necessarily the right thing investment wise. They are capable of stuffing up just like me, just their stuff ups are a bit bigger. Bhp bidding for Rio at the top is a case in point. They are not infallible.
      This goes for Governments as well. Common belief is that China will continue to grow at a rapid clip, but looking closely at the growth there are mal-investments with industrial overcapacity and empty housing/apartments for all to see.

      Having said that, I am not a disciple of the total bear camp, but am changing my take on the big picture as a trend.

      I also am a firm believer in Chris Martenson’s work on exponential problems filling the windscreen as we hurtle forward on a trajectory that many think is completely sustainable. I believe that this angle alone is going to shake peoples understanding of “value” big time.
      Just my take on things:)

      • Fair enough. Big miners stuff up, they lose money, and their shareholders suffer.

        Does it concern you that our policymakers have placed such faith in continuing Chinese growth, and are more than happy to see our trade-exposed industries wither and die (Holden bail-out excepted).

        • interested partyMEMBER


          I can’t recall where i read it but there is a very apt saying that says it is almost impossible to change someone’s belief or understanding when they rely on not understanding it to maintain their place in the status quo. Think swans and budgets and surpluses here.

          Regarding the trade-exposed industries, maybe if RBA were to join the global printfest and weaken the dollar, then that may help. Opens up another can of worms though.
          The damage was baked into the cake when we decided to go hell bent down the globalization path, and these industries appear to be collateral damage.

          • interested partyMEMBER

            As for Holden…………I have never owned a holden willingly, but I think i may have just bought one thanks to Julia!

        • ‘…more than happy to see our trade-exposed industries wither and die…’

          I doubt ‘happy’ is accurate – Stevens has mentioned the associated challenge and pain of structural adaptation often (read DEs overview of Stevens’ most recent speech).

          From an RBA/Treasury perspective it is easy to see that there is little alternative other than to embrace the resources boom (for as long as it holds). Housing, retail, some services all in the doldrums with limited prospect for rejuvenation any time soon. You only need look to economies that did not have a resources base to see how much REAL pain has taken place.

          We still have very low unemployment, low mortgage delinquency rates albeit fallout in the trade exposed sectors. I think you might find this pretty much the case around the globe, resources or not. This lends weight to the argument that manufacturing is under pressure from globalisation itself (read articles in recent Foreign Affairs). There are recessionary forces at work in most major economies.

          Reality is, we have had enormous demand for our commodities. This has been a gift to this nation. I can only repeatedly remind of HnH’s observation, without the boom we’d be toast (or Ireland).

          What would you suggest policymakers have done other?

          • BTW you might benefit from reading DEs recent (and excellent) discussions on forces at work in the Australian economy. 🙂

    • Throwing billions of dollars into investment with very challenging deadlines and pushing everyone in the (project) supply chain to breaking point, is a reasonably reliable way to erode shareholder value on a per share basis.

      • What do mean – that’s how it’s done – never been different.

        If you can’t take the heat, get out of the kitchen!

    • interested partyMEMBER

      Plenty of head scratching going on everywhere.

      This for/against argument is symptomatic of at least a moderation if not a trend reversal for the supercycle. We have been rising strongly for many years surrounded by debt driven economies happy to take our dirt, in one form or another. This leg of the stool is now gone. China’s export driven model for growth is now fading if not over so this leg of the stool is gone. The idea that china can turn industrial capacity inwards and grown internally through consumption is but a theory at the moment,and will take many years to implement. It can forced structurally, but getting the population to spend may be like pushing a piece of string. They are well aware of the problems that external countries are facing and how they arrived there. Maybe they don’t want the same outcome.

      As for the expansions planned by the bigs in iron ore, maybe……just maybe, these are the overshoot at the top of the market.
      Looking at the big picture as a chart here.