The COVID Commodity Supercycle Part 1
Many mainstream commentators are calling for a post Covid commodity supercycle based on recent rapid and extreme price rises. These have occurred over the past 12 months across a broad range of commodities; from oil in the energy complex, to copper in base metals, palladium in precious metals, even agriculture. What does this all mean?
Let us begin by first gaining some kind of understanding as to what a commodity supercycle actually is. The term “commodity supercycle” does not actually have a precise definition in terms of how much prices need to increase by, and for how long. Instead, it is used to loosely describe a situation where prices across the entire commodity space are increasing in tandem, and have done so for a prolonged period of time.
It is often used to describe the decade-or-so long rise in broad commodity prices that ended with the onset of the Great Financial Crisis in 2008. As the period of time also coincided with the rapid growth and development of China’s economy, Chinese demand was what mainstream narratives cited as the main reason behind the commodity supercycle.
But, regardless of how much of the increase in prices was down to the Chinese, the fact remains that commodity supercycles describe a situation where global demand far outstrips supply.
Furthermore, this supply-demand imbalance has to go on for years. Since commodity prices are cyclical and tend to rise and fall together with global economic growth, rising prices are not an infrequent occurrence. What is infrequent is when prices rise continuously for a relatively long period of time. The length of time is what the “super” part of “supercycle” refers to, and can be thought of as being influenced by two main factors.
The first is, of course, the length of the economic cycle (or business cycle as it is sometimes referred to) driving demand, and hence prices of commodities. Naturally, a longer cycle would see prices rise for longer.
However, what is also important is how large the difference between levels of demand and supply is. Obviously, a larger supply shortfall would mean a much quicker and higher rise in prices, but it can also mean that demand has outgrown existing production capacity. In this case, the only way producers can meet the elevated levels of demand is by building new production capacity.
Unfortunately, building new commodity production is a very time consuming process; one that is measured in years, and for the largest projects, decades. Consequently, commodity supply takes years to catch up with demand, which in turn leads to prices rallying for long periods of time – a supercycle.
To be continued…
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