The Coming Supercycle: Facts and Fantasies About Commodities

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by VBL
Saturday, May 01, 2021 - 17:58

Between 2004 and 2010 the broader commodity markets had an unbelievable run. While the oil and Gold  and silver markets didn't peak until around 2011-2012, all the consumed commodities, be they industrial or consumer, were on a tear.

Via Wikipedia

 The 2000s commodities boom or the commodities super cycle[1] was the rise of many physical commodity prices (such as those of food, oil, metals, chemicals, fuels and the like) during the early 21st century (2000–2014),[2] following the Great Commodities Depression of the 1980s and 1990s. The boom was largely due to the rising demand from emerging markets such as the BRIC countries, particularly China during the period from 1992 to 2013,[2] as well as the result of concerns over long-term supply availability.[citation needed] There was a sharp down-turn in prices during 2008 and early 2009 as a result of the credit crunch and sovereign debt crisis, but prices began to rise as demand recovered from late 2009 to mid-2010.[citation needed]

Oil began to slip downwards after mid-2010, but peaked at $101.80 on 30 and 31 January 2011, as the Egyptian revolution of 2011 broke out, leading to concerns over both the safe use of the Suez Canal and overall security in Arabia itself. On 3 March, Libya's National Oil Corp said that output had halved due to the departure of foreign workers. As this happened, Brent Crude surged to a new high of above $116.00 a barrel as supply disruptions and potential for more unrest in the Middle East and North Africa continued to worry investors.[3] Thus the price of oil kept rising into the 2010s. The commodities supercycle peaked in 2011,[notes 1] "driven by a combination of strong demand from emerging nations and low supply growth".[1]

[notes 2] Prior to 2002, only 5 to 10 per cent of trading in the commodities market was attributable to investors.[1] Since 2002 "30 per cent of trading is attributable to investors in the commodities market" which "has caused higher price volatility".[1][notes 3]

The 2000s commodities boom is comparable to the commodity supercycles which accompanied post–World War II economic expansion and the Second Industrial Revolution in the second half of the 19th century and early 20th century.[2]

On February 11th, Zerohedge published a story on JPM's analyst announcing he believed a new commodity supercycle was starting. Here is an excerpt:

Kolanovic: A New Commodity Supercycle Has Begun

Having dabbled in the fields of viral epidemiology and presidential polling, JPM quant Marko Kolanovic is set to conquer yet another "cross-asset": commodities.

Two days after Dylan Grice published an article "The Stage is Set for a Bull Market in Oil", with various commodities around the world soaring, and the price of oil up a stunning 64% since November, today Marko Kolanovic made a bold prediction - that the world has entered a new commodity supercycle:

It is generally agreed that over the past 100 years, there were 4 Commodity supercycles and that the last one started in 1996 . We  believe that the last supercycle peaked in 2008 (after 12 years of expansion), bottomed in 2020 (after a 12-year contraction) and that we likely entered an upswing phase of a new commodity supercycle.

The croatian quant first looks at history to answer "what drove the last supercycle" - according to him, "on the upswing, the most important driver was the economic rise of China (and EMs more broadly). USD was weakening and asset managers increasingly added commodity exposure to diversify portfolios." Then the 2008 global recession hit, coupled with further slowdown in Europe (2011) and China (2015) which sent commodities lower, defining the 12 year down cycle whose last leg "was marked by trade wars the ensuing global manufacturing recession, and the disastrous pandemic that sent oil prices into negative territory for the first time ever." This is summarized in the chart below.


The term "Commodity Supercycle" caught our attention. it reminded us of something we heard in 2004 by a head trader at Goldman Sachs. So after a cursory search we found the link between Goldman and JPM:

Kolanovic’s outlook is shared by many other analysts and investors, including Goldman Sach’s Jeff Currie, head of commodity research. In a recent interview with S&P Global Platts, Currie (who called the previous supercycle) said he’s bullish on oil and believes copper is likely already in a secular up cycle. “I want to be long oil and hang on for the ride,” he said in the February 5 interview.

And there was Jeff Currie, the Goldman analyst who touted the previous Supercyle corroborating the JPM market call.The author of this post recalls back then the negative carry or backwardation was the self-feeding factor that enabled the markets to run for so long.This now made sense. So we looked for the doc from back then on what the rationale was. Thankfully the internet did not forget. Goldman Sachs had declared a commodity Supercycle was imminent back then. In early 2004 the a global head of the Goldman Sachs GSCI product shared a document with the author of this post which outlined the rationale for commodities as an investment. This was at least in part the scientific basis for that Supercycle bull market call. This is that document.


Here is the follow up document that checked the work in 2015:


Here is where we are now:

According to the JPM quant, the downcycle is now over, and "the new commodity upswing, and in particular Oil up cycle, has started" driven by the following factors:

Of these, Kolanovic says that the upcycle will mostly be a story of:

  • postpandemic recovery (‘roaring 20s’),
  • ultra-loose monetary and fiscal policies,
  • weak USD,
  • stronger inflation,
  • unintended consequences of environmental policies and their friction with physical constraints related to energy consumption and production."

What he means by the last bullet is that as a result of dramatic capex curbs in recent years, with capital instead flowing to various pet ESG projects, there is not nearly enough capacity to meet future demands and the immediate outcome will be far higher prices.

It's not just the fundamental factors that form the basis for JPM's bold call: the bank also believes that the coming years will see a substantial repurposing of financial flows which have "an increasing role in asset pricing (e.g. vs. fundamentals)" is a consequence of "the electronification of liquidity provision, increased use of leverage, and rise of systematic trading strategies and related flows."

It is these increasingly fast and furious flows that "exacerbated the size and velocity of price moves both in commodities and related equities" during the last downturn, and these same financial flows "can have a similar impact on prices in the up cycle."

Marko then discuss some of the financial flows that he believes will impact commodity and related equity prices: we have excerpted his view on some of the key ones:

Inflation hedging: The past decade was marked by low growth and low inflation. Bonds, bond proxies and secular growth stocks were in a bull market, while commodities, value and cyclical stocks performed poorly. Kolanovic believes that the tide on yields and inflation is turning, which will pose "a major risk to multi-asset portfolios" and in light of the consensus view that commodities are the best way to hedge rising inflation, the JPM quant expects "these multi-asset portfolios to add commodity and commodity equity exposure to hedge inflation."


 Comment: It is fun to make light of Goldman's market calls as jaded old pros. But there is one thing you do not do; underestimate the power of a good idea with a firm's research, marketing, and trading desk behind it. For our purposes, we noted that back then Goldman was in fact buying and putting their money where their mouths were. Was it for captive orderflow or prop trading we don't know. But we do remember it seemed to never stop.  Watch the flows if you can and Good luck

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