COLUMN-Commodity prices: Supercycle or regular upturn? Kemp

(John Kemp is a Reuters market analyst. The views expressed arehis own)

* Chartbook: https://tmsnrt.rs/3k5SimR

By John Kemp

LONDON, Feb 16 (Reuters) - Commodity markets may be about toembark on another supercycle – a multi-year, broad-based, andusually large increase in prices – according to researchpublished by some of the top investment banks involved in thesector.

But while many prices are likely to increase over the nextcouple of years, after slumping during the coronavirus pandemic,it is less clear this will mark the start of a supercycle ratherthan an ordinary cyclical upturn.

Even a cursory inspection of historical time series showscommodity prices exhibit cyclical behaviour at all time scales,ranging from very short (minutes, hours and days) to very long(lasting months, seasons, years and even decades).

In a typical cycle, rising prices encourage more selling andproduction, and less buying and consumption, creating conditionsfor a subsequent price fall, before the pattern repeats.

In most cases, the cyclical behaviour of individual pricesshows only limited synchronisation across commodity markets (“Onthe development and impact of commodity prices and cycles”,McGregor et al, UNIDO, 2018).

So the term supercycle is reserved for the largest pricefluctuations and longest cycles, typically lasting more than 20years from trough to peak and back again, involving an unusuallybroad spectrum of commodities.

DEMAND SHOCKS

Past supercycles peaked in the 1910s, 1950s, 1970s and2010s, according to a study of prices for 40 agricultural,industrial and energy commodities by economic historian DavidJacks.

He argues that supercycles have usually emerged from theconsumption rather than the production side of the market (“Fromboom to bust: a typology of real commodity prices in the longrun”, Jacks, 2013).

Previous supercycles were driven by the industrialisationand urbanisation of the United States and First World War, thereindustrialisation of Europe and Japan after World War Two andChina’s industrialisation and urbanisation in the 2000s.

Jacks noted: "These are demand-driven episodes closelylinked to historical episodes of mass industrialization andurbanization which interact with acute capacity constraints inmany product categories – in particular, energy, metals, andminerals – in order to generate above-trend real commodityprices for years, if not decades, on end."

"However, once such a demand shock emerges, there isgenerally a countervailing supply response as formerly dormantexploration and extraction activities take off and inducedtechnological change takes hold. Thus, as capacity constraintsare eased, real commodity prices revert back to – and below –trend."

Huge increases in consumption are what distinguishmulti-year supercycles from the more routine rise and fall inprices (https://tmsnrt.rs/3k5SimR).

The critical question is whether there is likely to be acomparable increase in consumption over the next few years thatcould trigger a rise and fall in prices large and long enough toqualify as a supercycle.

THE NEXT DECADE

There are multiple potential triggers for alarger-than-normal upswing in the cycle over the course of thenext 5-10 years.

The next major economy likely to industrialise and urbaniseis India, which would be large enough to set off a supercycle,though it is less clear whether this will happen imminently.

Construction of new energy infrastructure to support climatetargets might also be large enough to trigger a supercycle, ifit happens fast enough and on a sufficiently large scale.

Finally, large-scale fiscal stimulus following the pandemicmight be enough to trigger a supercycle, though it is not yetclear if the stimulus will differ from ordinary cyclicalgovernment spending.

On their own, India's industrialisation, the energytransition, and large-scale government spending could all sparka supercycle, but the probability would be significantlyenhanced if they occurred in combination.

So far, however, all these are potential triggers; there islimited evidence they are underway or will spark a larger andlonger than normal upswing in commodity prices over the next fewyears.

Supercycles are defined by their relatively low frequencyand long duration. Not every downturn in the business cycleturns into a depression. Similarly not every upswing incommodity prices will become a supercycle.

There is a risk of overpredicting the occurrence ofsupercycles. The previous one peaked a decade ago. It ispossible another is now underway. But it would be arrivingunusually quickly.

Related column:

- Trouble looms for developing countries as commodityrevenues collapse (Reuters, Sept. 29, 2015)(Editing by Emelia Sithole-Matarise)