A dramatic rise in commodity prices over the past year has fuelled speculation that the world is entering the upswing of a new ‘supercycle’, a period in which structural shifts in the global economy power a long-term increase in commodity prices.
Non-fuel commodity prices were 38% higher in April 2021 than the same time in 2020 – the highest rate of growth since the 1970s.
Fuel prices have seen the sharpest rise since April 2020, when the initial phase of the pandemic pushed them to rock bottom. It is metals, however, that have powered the market into sustained inflation, with prices far outstripping pre-pandemic levels. The price of metals has risen by 55.9% since January 2020, compared with 12.5% for fuel commodities.
The boom and bust of commodity prices
While all markets are prone to booms and busts, commodity prices are notoriously cyclical.
In good times, a large part of the demand for commodities (particularly energy and metals) comes from the construction, capital goods and consumer durables sectors. All three sectors rely on consumers and governments deciding to make long-term investments, and so they tend to see rapid growth during booms and sharp declines during recessions.
Other sectors also see their demand rise and fall with the business cycle, but for commodities this problem is exacerbated by two factors.
First, commodity consumers are prone to stockpiling during economic upswings and running down these stockpiles during downswings, ensuring that upward and downward price movements are especially vicious for the commodities market. While the hospitality sector also sees demand rise and fall with the aggregate economy, for instance, consumers don't tend to stockpile restaurant meals or hotel rooms.
Second, commodity producers are unable to quickly react to changes in demand by raising or reducing their output. When the price of cars falls, auto manufacturers can shutter lines (and lay off workers) to cut production. When prices rise again, they can bring these lines back into operation.
Mines and plantations, however, cannot be turned on and off on a whim. Due to the enormous advantages of scale in mineral production, for instance, mines tend to run at close to full capacity. When prices rise, any significant increase in output would have to come from the construction of new mines and processing facilities – endeavours that can take years to complete.
Why are supercycles different?
Supercycles, however, are a different phenomenon altogether. These booms and busts take place over the course of decades, driven by long-term structural changes in the demand for commodities.
There have only been four such supercycles in the past 150 years. The first was fuelled by US industrialisation and the birth of the oil era in manufacturing, shipping and automobiles. The second resulted from the post-war European recovery, while the third was prompted by the sudden increase of the price of oil in the 1970s.
The most recent supercycle, widely attributed to the economic rise of China, saw non-energy commodity prices triple between 2001 and 2011, before falling 41% by 2016.
While the surge in commodity prices is certainly historic in speed and scale, it is not yet clear whether it signals the beginning of a new supercycle or is simply part of a broader rally across the economy.
A glut of capital available for investment has pulled interest rates to record lows, and may now be powering the current rise in asset prices – most notably tech stocks, but also commodities.
Investors have piled into the commodity market in recent months, with the price for a ton of copper doubling to more than $10,000 in the past year. Bloomberg reports that "the word from Wall Street is 'don't stop buying now'", with Bank of America predicting that the price of copper could double again to $20,000 per ton.
While financial speculation is no doubt playing a role, the rise in consumer prices suggests that traditional supply and demand mechanisms are also in motion. Pandemic-related stimulus payments have maintained consumer spending power, staving off a depression, even as lockdowns and supply chain disruptions make it difficult for companies to meet this demand.
April 2021 saw the biggest rise in consumer prices in the US since the 1990s, with year-on-year inflation of 3.1%, while freight prices have reached levels not seen since the global financial crisis. This latter trend has been attributed to a scarcity of empty containers, a result of disruption in the early stages of the pandemic.
Supercycle or bust?
If the commodities boom is an artefact of a broader economic recovery meeting strained supply, supply chain recovery or a dip in government stimulus spending may be expected to lead to a commodities bust. The World Bank warned as such in April, noting that a faster-than-expected withdrawal of spending could pose a downside risk to commodity prices.
Even if the current boom is cyclical, however, many investors have their eyes on longer-term dynamics that could turn the current price inflation into a decades-long supercycle.
As the World Bank noted, a cyclical decline in commodity prices could be offset by a large increase in infrastructure spending, whether to repair crumbling roads and bridges or to achieve decarbonisation.
The Biden administration's proposed $1.7trn infrastructure plan for the US is being closely watched by commodities investors. The plan extends not only to traditional infrastructure projects but also to the installation of solar panels and wind turbines, with $174bn earmarked to promote the electric vehicle market.
The bill could therefore provide a major stimulus to demand for commodities used in traditional construction projects, such as iron ore, copper and aluminium, as well as commodities essential for the energy transition such as lithium, tin and nickel.
Whether Joe Biden will be able to secure his preferred spending plan, and whether other countries follow suit, is difficult to predict. Analysts at GlobalData offer a less rosy picture than Bank of America, predicting that key commodity prices will fall by 2025.
The price of iron, having risen by 84% since the start of 2020, is expected to fall by 64% by the end of 2025. Zinc and silver are also expected to see their prices diminish, despite impressive rallies over the past 12 months. Only copper, an essential component of renewable energy systems, is expected to ride out the downturn, with prices rising a further 6%.
The chances of a rupture with the status quo, however, are difficult to factor into such models. Keeping global temperature rises below 1.5C, as per the 2015 Paris Agreement, will require a 45% cut in emissions by 2030 (from 2010 levels), compared with the 1% reduction for which the planet is currently on track.
Meeting the target will require a fiscal response on the scale of Covid-19, but sustained for decades. The OECD estimates that meeting climate and development goals will require $7trn in annual investment, slightly less than the $8trn spent last year on combatting the effects of the pandemic.
If the current commodities boom is to translate into a long-term structural shift in the global economy, it may depend less on the economic and technological drivers that gave rise to past supercycles than on the outcomes of coming political battles over the future of the planet.