Why the new commodity boom is a fake

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Macro Afternoon

Since the great 2020 COVID-crash in markets, there has been an increasing siren song for a new supercycle in commodities. MB agreed with to this an extent given the cycle of extreme stimulus, led by the US Federal Reserve, which has set about debasing the US dollar. Such early cycle environments are always supportive of commodities as they are priced in USD so rise as it falls. As well, China typically uses aggressive building stimulus which increases underlying demand. But does this a super-cycle make?

In the pre- and post-GFC environments it did. But the key then was that there were also structural supply-side shortages as runaway Chinese demand outstripped mines, transport and infrastructure capacity. No such shortage exists today because the build-out over that previous cycle was so enormous.

Still, some are still arguing that a new super-cycle is upon us. Doug King at Merchant Commodity Fund argues today at Bloomberg that pent-up consumer demand globally will fire the cycle. So far it has:

We might add developed economy stimulus, especially in the US, targeting infrastructure and energy transformation.

But I see several problems with this thesis.

First, there isn’t much pent-up demand in goods. Much of it is in the neglected high-touch services, and as economies reopen that is where the boom will come. There is an ongoing global goods inventory rebuild over this year but by next it will peter out. I fear that consumer demand for goods, including home office build-out, has been brought forward by the COVID cycle and expect a demand pull-back as fiscal supports normalise. In short, commodity-supportive pent-up demand is happening now not ahead.

Infrastructure will be supportive ahead, especially climate-related, but in developed economies, these tend towards commodities that are heavily recycled or locally produced such as steel and concrete. Base metals such as copper and lithium will be in demand but the shortage is minor and will only necessitate a new large mine or two.

Oil, too, is in abundance. US shale can switch on fast and OPEC still has 6mbpd spare capacity. Not to mention that falling oil demand is right around the corner. Gas is in a massive global glut.

Doug King also cites the need for higher inventories as deglobalisation transpires, but that is only at the margin and won’t take long to deliver. It’s certainly not a structural driver.

Second, and most importantly, the better the global recovery is, the faster that China will tighten. It was borderline overheating at the turn of the year. The tightening has already begun with the Chinese credit impulse rolling and more is coming:

China is also planning deleveraging reform for its property development sector which will hit demand for bulk commodities especially.

In short, Chinese demand growth for many commodities will be falling from mid-year and into 2022 which will easily offset rising developed economy demand. Again, we’ve already seen the pent-up demand.

This is not to say that certain commodities won’t be hot this year. La Nina is always disruptive to softs. And geopolitical events such the Chinese trade war on itself will pop prices here and there. 2021 will be a good year for commodities simply on the basis of a falling USD and global recovery.

But beyond that, as China slows and Europe underperforms into 2022 owing to a lack of fiscal support, both CNY and EUR will want to fall and DXY will begin to rise chasing higher US yields and better growth.

So 2022 sees both demand and financial headwinds for commodities.

Hence, the current bull market looks a lot more like a typical cyclical commodities recovery than it does the return of the supercycle.

David Llewellyn-Smith

Comments

  1. ashentegraMEMBER

    I expect Cu and Nickel Sulphate to benefit from the electrical revolution and disagree with your assessment only a few big mines are needed. Cu will have fresh, insistent, price-insensitive demand from electric car manufacturers. We can argue about the speed of the transition and exactly how much Cu is needed per vehicle, yet cannot ignore the high future demand. Lithium? I shrug. Zn will be steady. IO depends on China and Brazil. Your guess is as good as mine.

    Fossil fuels will be interesting. Steaming coal requires high S-I-B capex, so prices will likely stay up… until they don’t. Aviation is a major oil consumer and much depends on how quickly tourism recovers. It is soon to face falling transport demand as the heaviest users are the most motivated to change to electric.

  2. Fair enough.

    My thoughts:

    Though I have a feeling that people are under-estimating that renewables and EV building boom, and the associated coming gradual decreases in global energy prices (which will also surely drive down coal, gas and oil), upon which some manufacturing can grow and regrow. Everyone’s gonna do it. And already. Genuine industry, genuine increases in utility.

    All that hot money wants to go somewhere, and it actually DOES have somewhere legitimate to go to – renewables, and its associated downstreams and upstreams.

    To those that think I’m over-stating renewables – yes, that’s possible; but I think it’s more likely that those same people are under-stating renewables, and associated pure, legitimate industrial and economic benefits.

    My 2c

    Yes, I’ve become a renewables fanboi (and used to be a coal fanboi, and work in the coal industry).

    • “Future predicted increased demand for lithium for EV batteries alone is staggering, with a predicted doubling from approximately 12,500 tonnes in 2018, to 25,000 tonnes in 2020, to 150,000 tonnes in 2025, to 425,000 tonnes in 2030 with a linear increase of an additional 100,000 tonnes per year, every year until 2050.

      This growth will, of course, be compounded by additional growth in the demand for batteries associated with consumer goods and for household and utility grid storage.”

      https://fbicrc.com.au/wp-content/uploads/2020/10/20-00191_MR_REPORT_FBICRC-StateOfPlayBattery_WEB_201002.pdf

      • And that’s just lithium batteries.

        Add flow batteries (vanadium et al) to that list, too…which are probaly going to push lithium batteries out at the utility-scale end…

        • Yep. The FBICRC-CSIRO report I linked to above also touches on vanadium. There are three prospective vanadium projects in Australia that, if realised, will add 17 percent to global supply. However, the forecast need for vanadium in redox flow batteries significantly exceeds this.

        • “which are probaly going to push lithium batteries out at the utility-scale end…” – Recent advances with solid state Li batteries might put a spanner in those works…. if QuantumScape’s developments are genuine, then we’re soon to be in for step-change improvements in Li battery performance which will destroy most of the competing technologies overnight

  3. Apart from the points made in this article I wonder how such a supercycle will be funded. I am talking about the industrial metals. Point being any usage of these metals require a lot of debt. If we start getting any inflation at all, that will necessitate the need to raise rates thereby choking off any growth before it gets going. The alternative is to run repressive -ve real rates ie inflation starts to rise but interest rates are pinned down by central banks. This obviously would destroy the currency of any country that tries to do it. Point being I can see the argument for inflation in agricultural, gold/silver and other small consumables, but anything that requires massive amounts of more debt seems unfeasible ie iron ore and other industrial metals.

  4. Nice commentary.

    I think there are a couple of factors that are supportive; we may well see a much bigger fall in the $$$ than people currently expect and that translates into the cycle for commodities, as does a lift in inflation. Also, I think we are going to see greater demand not just for things like lithium but also the realisation in the US-Europe that they need to get their rare earths locally and not from China. Also, the news from SA on AstraZeneca and comments from virologists suggests we aren’t going back to BAU any time soon and that likely means further disruption of supply (eg Platinum from SA). We could also see disruption in agricultural commodities So the cycle may extend beyond the simple China credit story.

    Although that doesn’t take away your key point. The mega-boom in the early millennium is hard to repeat.

    • “Also, I think we are going to see greater demand not just for things like lithium but also the realisation in the US-Europe that they need to get their rare earths locally and not from China. ”

      Yep, the US and EU are scrambling to secure non-Chinese supplies of rare earths.

      Lynas shares jumped following the announcement last month that the Australian rare earths company had entered into an agreement with the US Department of Defence to build a rare earths separation plant in the US.

      • Yep its amazing that only 1 year ago LYC was trading a shade over $1 ps…

        Their Mt Weld resource is truly world-class and oh so advantageously positioned geographically and politically….then there is their in-house expertise. glad I bought a small piece of it pre-COVID!

        • A bit annoyed that I didn’t buy Lynas shares a while ago. The company hasn’t had an easy ride. But its fortunes arguably changed when the Japanese government came onboard. Now the rest of the world is rushing to secure non-PRC rare earths.

  5. “Not to mention that falling oil demand is right around the corner” – really, based on the world re-opening post-Corona and as global aviation is re-born? interesting

    “Gas is in a massive global glut” – really? did LNG cargoes recently not sell for US$30 + per MMBtu ? record prices like these would not point to a ‘glut’, but rather periodic shortages of supply in certain regions during certain months of the year… LNG is very price-sensitive to distance shipped, and LNG plants are often far from regasification terminals that demand the product. China’s demand for LNG is exploding as it makes a concerted effort to displace its reliance on thermal coal with the stuff…watch this trend develop through 2021.

    As for China, I’ll believe its appetite for commodities is waning when I see it !