The COVID Commodity Supercycle Part 2
Ironically, the same productive capacity that was built to meet elevated levels of demand also sows the seeds of the supercycle’s end. This happens as producers, who are all scrambling to supply as much as possible in order to make as much money as they can, bring so much new supply online that the market becomes oversupplied.
In addition, it is important to remember that commodity supercycles track global economic cycles. Which means that when economic growth turns down (for whatever reason), commodity prices quickly follow suit. This sudden fall in current and projected demand, in an environment where producers are bringing new supply to market at a furious pace, creates an immediate surplus, and prices crash in response.
Notice how the supercycle started as a shortfall of supply relative to demand, and ended when that relationship inverted to become a surplus of supply versus demand. Just as the rush to bring more supply to market brings about the end of a supercycle, the surplus of supply when the cycle turns creates the conditions necessary for the next rally in commodity prices.
This happens as producers frantically cut their production, go bankrupt, or consolidate their operations. All of these actions reduce the supply of commodities in the market, allowing prices to recover, and the cycle to begin again.
Now that we know what supercycles are and how they come and go, we can answer the real question. Can Covid drive a new commodity supercycle?
The dramatic price rises in many commodity markets have been attributed to strong demand and supply disruptions in those markets. Naturally, the supply disruptions are related to Covid, and tend to be a combination of suppliers reducing their levels of production and supply chain issues, which creates difficulties in transporting commodities to end users.
Strong demand, on the other hand, is also related to Covid, and is attributed to the economies of many countries either starting to reopen again, or returning to some form of normalcy. This has boosted demand for raw materials as consumer demand comes roaring back all at once, and businesses race to increase production as a result.
Hence, we know that supply is lower and demand higher, which obviously leads to higher prices. However, how much of the current price rally is due to supply disruptions from Covid, as opposed to robust demand?
In other words, is current demand due to reopening effects – that is delayed projects coming back online, rather than coming from new projects? The purpose of this question is to distinguish between economic activity that is “catching up” with time lost during lockdowns, and activity that is due to companies being confident enough in the future to invest in capital expenditures today. Needless to say, the more demand for raw materials is due to “catching up” activity, the less sustainable it is, and the less likely to drive a commodity supercycle.
To be concluded…
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