The last decade has seen an incessant rise in commodity prices. Most commodities touched all-time highs leading to predictions about a continued bull-run for the next decade or more. At the crux of this prediction was the supposedly ?proven? history of the commodity supercycle. But with prices crashing through the floor, what now?
The phrase was made famous by successful fund-trader Jim Rogers who theorised that since the average commodity bull run was 20 years long, the latest one still had more than a decade to go before it ran out of breath. The caveat: the bull run would be punctuated by some nasty corrections and what you see today is one of those corrections.
Many today believe that the cycle is still alive and well and will end with inflationary depression. With the US government printing currency, hyperinflation will take commodity prices to stratospheric levels again, and only then will the current commodity supercycle start the downward spiral. This school of thought contends that production of commodities has become more efficient over time with technological advancement and only unbridled increases in money supply will lead to high commodity prices. This process can certainly recur as a supercycle every two or three decades as is borne out by history.
A war or some innovation or the tinkering of fiscal and monetary policies by governments or a combination of these can also produce a situation that leads to increased demand and therefore higher prices. To take advantage, producers invest more and more to increase capacities and reach a situation over years that supply exceeds demand?leading to the beginning of the downward leg of the cycle. For example, when crude oil was touching $10 a barrel just ten years ago, investments in exploration, drilling and refineries stopped?leading to capacity shortages recently which helped push up prices. The recent price rise saw billions of dollars of investment go into the very same areas?helping the prices fall as the fear of shortage evaporated.
Nevertheless, the outcome of supercycle peaks may not be that obvious. The extremely high crude oil prices in 1978-1980 have seen per capita consumption of liquid crude fall from 5.3 barrels per person per year to 4.8 in 2007. The new energy mix now consists of increased amounts of natural gas and coal. Similarly, the recent new highs in crude oil will certainly increase the resolve of developed countries to find an alternative. The focus would once again be on using renewable bio-resources as fuels because depletion and exhaustion lead to wild price swings.
So what are the likely trends today? Each commodity will be determined by its particular characteristics. Crude oil prices continue to look down with a fall in absolute consumption in developed countries and a fall in consumption growth rates in hitherto fast-growing ones like China and India. For the same reason, base metal prices are set to have a sideways to downward trend. Agri commodities are down some 30% on average but are best placed for a second wave?the affluence spread in the last five or six years has changed table habits irreversibly for a large population. Finally, bullion too has fallen 30% from its highs in March ?08.
The implications of the ?nasty correction? are many. Financial discipline is a buzzword again and hedging in commodities is back in fashion. Secondly, the fear of inflation continues to loom large and must be tackled. Third, mergers and acquisitions will gain speed and the biggest beneficiaries will be large companies from historically conservative countries like India. Four, consumption rationalisation will become more evident as the retail movement slows a bit but becomes more mature in India. Central banks worldwide will start to act in concert (and harmony) and be more coordinated.
In any case, periods of high growth with firm commodity prices are much better than a recession with low prices and one eventually leads to the other. That?s what commodity supercycles are all about.
The author is head of Religare Commodities. These are his personal views