Following the devastating impact of the coronavirus pandemic on financial markets around the world, the recent surge in commodity prices appears to suggest growing investor confidence for the future.
Oil prices have jumped by around 20 per cent since the start of the year to pre-pandemic levels, while gold has soared to a new record. Meanwhile, copper, which is often viewed as the bellwether of the industrial metals sector, hit a nine-and-a-half-year high at the end of 2020, fuelling talk of a new commodities super cycle.
Price swings are par for the course in any market, but the term “super cycle” is reserved for the very largest fluctuations, when commodities rise above their long-term price trend for a lengthy period, often several years, even a decade or longer.
The industrialisation of the United States at the end of the 19th century and the post-war re-industrialisation of Europe and Japan in the late 1950s are two such examples. More recently, the rapid economic growth of BRIC countries, most notably China, sent demand for commodities and with it, prices, soaring in the early years of the millennium.
But, the global financial crisis, coupled with slower than expected Chinese consumption proved significant headwinds for the sector, sending the S&P/Goldman Sachs Commodity Index plunging by 60 per cent over the course of the last decade.
After languishing in a bear market for the past ten years, 2020 saw commodities find favour with investors once again. The Bloomberg Commodity Index rose 10 per cent in the fourth quarter alone, prompting analysts to declare the sector is displaying structural similarities to that of the early-2000s.
Start of a new super cycle?
On the face of it, the signs are certainly positive. The Chinese Caixin manufacturing purchasing managers’ index reached a ten-year high in November 2020, implying increased demand for commodities. Meanwhile, a weakening US dollar, combined with widespread fiscal stimulus, has stoked concerns of growing inflation, against which commodities have historically been used as a hedge.
According to commodity analysts at J.P. Morgan: “The past decade was marked by low growth and low inflation. Bonds and secular growth stocks were in a bull market, while commodities and cyclical stocks performed poorly. We believe that the tide on yields and inflation is turning.”
The new commodity upswing, and in particular oil up-cycle, has started. Mostly, it will be the story of “post-pandemic recovery, ultra-loose monetary and fiscal policies, weak US dollar, stronger inflation, and unintended consequences of environmental policies and their friction with physical constraints related to energy consumption and production”, says J.P. Morgan.
Commodity bulls also stress the impact of the green industrial revolution upon the sector, with countries across the globe vowing to spend big to meet climate targets.
China, the largest energy producer and consumer in the world, recently committed to become carbon neutral by 2060. Beyond China, the US Biden administration has set a new $2-trillion green deal, while the European Union has pledged to reduce greenhouse gas emissions by at least 55 per cent up to 2030, compared with 1990 levels.
Analysts at Goldman Sachs believe this transition has the potential to create $1 trillion to $2 trillion a year in infrastructure investment, surpassing oil and gas drilling for the first time.
Commodity headwinds
While the building blocks for a commodities price growth look to be falling into place, many experts warn it is too soon to label the recent upswing the start of a new super cycle.
Scott Gardner, investment strategist at Charles Stanley, explains: “For a commodity super cycle to occur, we need two macro factors to be in play: a weaker US dollar and above-trend economic global growth.
“A weaker dollar can arise from further easing by US authorities and, given the infrastructure plan and commitment to the easy financial conditions from the US Federal Reserve, we currently have that condition.
“Secondly, we need robust economic growth globally. During the 2000s, as China emerged into the global marketplace, the demand for commodities increased dramatically and helped fuel the 2000’s super cycle. We currently don’t have an emerging economic superpower at a similar stage to where the Chinese were.”
Given the increased hostility from governments and corporates globally to traditional fossil fuels, this is a secular headwind
Some analysts believe that while there is an argument for a more bullish market across certain commodities, it is difficult to anticipate the same level of demand for commodities such as oil, which makes up a significant proportion of the sector.
As a result, investors need to be aware of risks associated with broad-based commodity indices, says Gardner.
“Depending on the commodity index, energy comprises between 25 and 40 per cent of the index. Given the increased hostility from governments and corporates globally to traditional fossil fuels, this is a secular headwind. Investors should focus on specific commodity groups, namely metals. There is also the secular trend towards cleaner, greener energy via electrification,” he says.
Indeed, lithium, a crucial component of electric vehicle batteries is up 88 per cent this year, while palladium, used in catalytic converters, reached record highs in 2020.
Michael Hewson, chief market analyst at CMC Markets, comments: “We are likely to see a shift in supply and demand across certain metals. However, offsetting that will be a decline in fossil fuels such as coal and oil. While one might argue that price spikes will occur, it will not be enough to warrant being called a super cycle.”
Investors should avoid placing all their eggs in one basket. Hewson says: “It’s important investors don’t focus on one particular commodity, but rather create a basket of companies to diversify the risk.”
He advises that investors could benefit from considering companies not directly in the renewables sector, but which offer services to these firms, as a way to gain exposure.
While wisdom has taught us to expect the unexpected when it comes to commodities, the jury remains firmly out on whether we are in the throes of a new super cycle. But one thing is certain: commodities are likely to keep investors on their toes as we enter a new post-pandemic era.
Following the devastating impact of the coronavirus pandemic on financial markets around the world, the recent surge in commodity prices appears to suggest growing investor confidence for the future.
Oil prices have jumped by around 20 per cent since the start of the year to pre-pandemic levels, while gold has soared to a new record. Meanwhile, copper, which is often viewed as the bellwether of the industrial metals sector, hit a nine-and-a-half-year high at the end of 2020, fuelling talk of a new commodities super cycle.
Price swings are par for the course in any market, but the term “super cycle” is reserved for the very largest fluctuations, when commodities rise above their long-term price trend for a lengthy period, often several years, even a decade or longer.
