Commodities’ time to shine

Texas, 1930. Columbus Marion Joiner has just struck gold. Or rather, black gold.

He doesn’t know it yet, but he’d just made history. The East Texas Oil Field was the biggest oil discovery ever.

The US had seen its fair share of oil discoveries since the 19th century, but the East Texas Oil Field dwarfed the rest.

And then, the oil price crashed. Supply had shot up, as men from across the country scrambled to the area in the hopes of making their fortune.

Then the price stabilised. Desperate to preserve Texas’ key industry, the governor tried to throttle supply by shutting down wells.

Wild spikes and troughs in prices were not unusual during America’s oil rush.

Just as the American oil rush is a pretty stark example of how oversupply can tank commodity prices, then 2020 demonstrates the flip side of this – how a lack of demand can pummel prices too.

As the world went into lockdown last year, commodity prices fell off a cliff. Oil was particularly badly hit as Saudi Arabia and Russia turned on the taps and flooded the market with excess supply at the same time as demand was plummeting. But other commodities – from copper to coffee – took a beating too.

But now the tables have turned. Investors are increasingly bullish on commodities. Copper, iron, and even some non-metal commodities are hitting multi-year highs.

It’s not over yet, either. Some are predicting that the current boom in prices could last over a decade.

That’s exactly what Goldman Sachs predicted in a recent research paper.

If commodity prices crashed in the first half of last year, it makes sense that they would pick up – but Goldman Sachs’ prediction goes beyond that: it predicts a “structural bull market” for years to come.

So what’s going on?

A commodity super cycle on the horizon?

“Commodities” itself is a big term. It encompasses a range of materials that we use to keep us warm, move us around, clothe us and feed us. Copper, corn, iron, oil, coffee, natural gas, cobalt, and cocoa – all of these fall under the “commodities” umbrella.

As countries have begun to emerge from lockdown, bleary eyed and squinting (much of western Europe not included), there’s been growing chatter amongst analysts about the possibility of a new commodities “super cycle”.

In short: commodities – from the fuel you put in your car to the cobalt in your mobile phone – could be on the verge of long-term, unusually high price increases.

And that’ll be great news if you’re, say, a copper miner or an agricultural company. But not so for the average consumer. If commodity prices go up, so does inflation, and it’s the man on the street who really starts to feel the pinch as inflation sets in.

Imagine a set of scales: on one side is supply; the other, demand. If the scales tip towards the demand side, with little supply to counterbalance it, then prices will rise. If this state occurs for a long period of time, then it’s what we call a super cycle.

It’s happened before – most recently in the 2000s. For over a decade, commodity prices pushed further and further upwards as large developing countries such as Brazil and India developed at a massive pace.

All of this might sound strange given what we’ve seen over the past year.

You probably remember when the oil price in the US briefly dipped below zero for the first time ever. Oil wasn’t the only thing that nosedived last year. So did iron, copper, and cobalt, among others.

But if the stars are to align and commodities are to head into another decades-long bull run, a few things need to happen.

First, the value of the US dollar needs to fall in value.

Why? Because US dollars tend to be the currency commodities are traded in. The cheaper the dollar, the more a factory in Brazil or India can buy.

And that’s exactly what a forecast by analysts at Citigroup, the international investment bank, predicted last year. A vaccine means that there’s finally an end in sight to the pandemic. And that means that big-money investors are willing to take a chance buying riskier assets with higher yields – many of which aren’t priced in US dollars.

Take a look at the graph below. It shows the US Dollar Currency Index over the past five years – an approximate gauge for the strength of the dollar.

It’s tumbled to its lowest since 2018 – and that’s with plenty of the world still in lockdown.

Source: Yahoo Finance

So what else is on the horizon that could boost demand and set a fire under commodity prices?

You only need to have a quick scroll through the news to see that politicians of all stripes are touting a green recovery from the pandemic.

From Boris Johnson promising to make the UK the “Saudi Arabia of wind” to President-elect Joe Biden’s promise of a $2 trillion “Green New Deal”, governments across the world are viewing green infrastructure as the key to getting economies moving again.

Spending money is back in fashion – governments have loosened the purse strings and will continue to do so to ensure that their economies recover. Even when economies crash in the future, governments and central banks are likely to do whatever they can to pick them up, brush them off, and send them on their way.

It’s also pretty easy to forget that while we’re sat at home twiddling our thumbs under the latest lockdown, some parts of Asia are back to normal for the time being. Or at least, something resembling normal.

With people across the world’s most populated continent buying cars, building houses and upgrading their phone, some commodities are being hoovered up at a rapid rate.

Chinese demand for copper has already sent the copper price through the roof – nearly doubling since March – and defunct iron mines in Australia are beginning to reopen to ride the wave of demand from the continent.

A future where we all drive electric cars and heat our homes with hydrogen sounds great, but countries will need to rework their existing infrastructure to make it a reality. And that’ll take plenty of resources.

Let’s use electric cars as an example. You’ve probably seen the endless stream of adverts for them at the moment. Perhaps you own one yourself.

To make the battery for an electric car requires a lot of lithium. Compared with your average diesel or petrol car, they use around four times more copper too. And with China already adopting electric vehicles, that will only continue to push up demand for metals.

That’s more weight on the demand side of the scales.

And if stock markets are anything to go by, then this may well continue.

Stock markets are forward looking. A share’s price – at least in theory – reflects what investors expect will happen in the future. So a quick look at the share prices of a few commodity companies suggests investors may have some pretty high expectations for commodity prices down the line.

Take Antofagasta and Southern Copper Corporation, for example. Both are copper miners, both are at multi-year highs.

Then there’s Fortescue Metals Group and BHP. Both are iron ore miners, both are at multi-year highs.

So looking at the numbers paints a pretty bullish picture for a lot of commodities. The pieces are in place for increased demand.

The spark to set commodities on fire

For a commodity super cycle to really take off, supply will be unable to keep up with rising demand – ultimately pushing up prices.

For years, the price of raw materials has been lacklustre, to say the least.

Let’s take oil for example. Its priced crashed hard in 2014 and since then it’s struggled to recover. Why spend millions of dollars searching for new oil reserves if it’s barely – and in many cases, not – profitable to pump it out of the ground?

According to a Goldman Sachs’ report, there’s been underinvestment in many raw materials for a while.

And when it comes to increasing supply, there aren’t many quick fixes.

I hate to be the bearer of bad news for any aspiring copper tycoons out there, but if you want to open a copper mine and get in on the current bull market, it won’t happen overnight.

In short, it takes a while to bring new supply online. In the meantime, prices often continue to climb.

It’s a particularly messy picture for oil and other “dirty” industries. Investors and banks are increasingly wary about throwing money at such projects, whether because they are required to divest from fossil fuels or because they don’t want the bad press.

It looks like a perfect storm for commodity prices. The supply side of the scales is looking light. On the other side, demand is heavier than ever.

Maybe we’ll see another American oil rush yet.

All the best,

Nathan Tipping
Research Analyst, Southbank Investment Research

PS While commodity prices look set to climb, there’s one metal in particular that Boaz Shoshan and Nickolai Hubble believe could soar in the near future. That’s why they’ve produced an exclusive report explaining why the metal is on the cusp of a breakout and which assets could benefit. To find out more, click here.

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