More commodity super-cycle speculation

See the latest Australian dollar analysis here:

Macro Afternoon

I am consistently surprised at how thin-sliced Wall Street analysis is. The new commodity supercycle meme that has taken hold in recent months is a great example. Late to the party but now on board is JPMorgan:

It is generally agreed that over the past 100 years, there were 4 Commodity supercycles and that the last one started in 1996.We believe that the last supercycle peaked in 2008 (after 12 years of expansion), bottomed in 2020 (after a 12-year contraction) and that we likely entered an upswing phase of a new commodity supercycle (e.g.we increased commodity allocation in our GAA report).What drove the last supercycle? On the up swing, the most important driver was the economic rise of China (and EMs more broadly).USD was weakening and asset managers increasingly added commodity exposure to diversify portfolios (e.g.Yale model of diversification via alternatives). The 2008 global recession and further slowdown in Europe (2011) and China (2015) sent commodities lower. Figure1 shows the last supercycle for Oil with various specific drivers that drove the 12-year up cycle and 12-year down cycle. The last leg of the oil down cycle was marked by trade wars and the ensuing global manufacturing recession, and the disastrous pandemic that sent oil prices into negative territory for the first time ever. We believe that the new commodity upswing, and in particular Oil upcycle, has started and list its likely drivers in Figure2. Mostly it will be the story of a post-pandemicr ecovery (‘roaring20s’),ultra-loose monetary and fiscal policies, weak USD, stronger inflation, and unintended consequences of environmental policiesa nd their friction with physical constraints related to energy consumption and production.

Over the past several years, financial flows are having an increasing role in asset pricing (e.g.vs.fundamentals). This is a consequence of the electronification of liquidity provision, increased use of leverage, and rise of systematic trading strategies and related flows. During the last downturn, this exacerbated the size and velocity of price moves both in commodities and related equities. We believe that these financial flows can have a similar impact on prices in the up cycle, and below we qualitatively and quantitatively (where possible) discuss the financial flows that will impact commodity and related equity prices.

So, let’s go through those drivers:

  • End of the pandemic and catch-up growth boom is positive.
  • End of the trade war. Says who? I don’t see Biden cutting tariffs. Manufacturing is enjoying temporary catch-up growth and inventory boom cycle.
  • Ultra-loose monetary policy only matters to commodities while the USD falls. It only has 10% downside left in my view as CNY and EUR role later this year.
  • More inflation. Maybe. Probably not.
  • Infrastructure is bullish but most commodities are recycled in developed economies and raw material commodity-centric Chinese stimulus is already winding down.
  • Inflation hedges sure, if there is any, which comes largely from commodities, so this is circular.
  • MoMo will follow up or down.
  • ESG and climate are positive but even these don’t need more than a mine or two of copper and lithium.
  • Oil is everywhere and shale ready to boom if needed plus ESG kills it.

Basically, unless we see a fully-fledged MMT boom that builds like mad across the developed world, that is so big that it can offset what is clearly a coming shift down in Chinese consumption growth, then the supercycle thesis is bull.

Oddly, the most bullish scenario I can see for commodities is the one in which the virus materially plagues global demand for years requiring ever more stimulus, especially in China.

At this point, this is a normal cyclical recovery for commodities that is going to run into a return to Chinese economic restructuring sooner rather than later.

Two years of upswing does not a supercycle make.

David Llewellyn-Smith
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  1. DLS – your comment on “Infrastructure is bullish but most commodities are recycled in developed economies and raw material commodity-centric Chinese stimulus is already winding down.”
    Are you talking about steel specifically? The proportion of base metal recycling (probably with the exception of lead) is nowhere near significant vs the incremental demand growth if major infrastructure programs are pushed around the globe. Also not easy to switch on a big new base metal mine. Also grades of most existing base metal mines (copper specifically) are dropping so you need new supply just to replace that loss…

  2. Wall Street is full of shit. There will be no catch-up boom as American consumers struggle with unemployment, stagnating wages and debt. Consumers make up 70% of GDP and that is why US is struggling. Same with EU. China is more goods orientated and is only one to grow. Soon gap will close between exuberant stocks and weak global economy.

  3. I would say there is going to be a new super-cycle.
    The pandemic is a smoke screen for MMT. Its happening now with all central banks printing money, and its going to continue until there is rampant inflation – ie supercycle.
    There is already talk about extinguishing the govt debt increase caused by the pandemic. The central banks simply forgive the debt they have purchased. And then the govt can borrrow more.

  4. Don’t Wall Street talk down things that they are buying and talk up things that they want to sell? Is that how it works or am I too cynical?