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The End of the Commodities Super Cycle
Has the so-called commodities super cycle, which has benefited economically backward but resource-rich countries for the better part of two decades and contributed to an astonishing increase in global trade, run its course?
Economists are arguing that, with the prices of such elemental goods as coal, oil, copper and grains having fallen dramatically, the cycle is over. In the past two years, coal prices have fallen by 40.3 percent from their peak, oil is off by 19.1 percent despite Gulf tensions and copper has declined by18.5 percent. Grain price declines have been relatively moderate, with corn and soybean prices showing drops of around 10 percent.
The question whether the super cycle is over has serious implications for poorer countries, many of them in Asia but more in Africa, that have supplied coal, timber, crude and a wide range of minerals to China and the developed world. Their national budgets face trouble.
This is especially true of the countries that have succumbed to the so-called resource curse, in which governments go for cheap and exploited resource-based revenues rather than spending money on more balanced development. Job creation, education and other expenditures suffer as well. The phenomenon is also called the Dutch disease, a concept that explains the apparent relationship between the increase in exploitation of natural resources and a decline in the manufacturing sector. Once the Netherlands discovered it had oil underground, manufacturing output fell.
Economists refer to the super cycle as a pattern of long-term price trends reaching back into history for almost 150 years through depressions, droughts, wars and inflation. They normally involve a decade of rising prices followed by two decades of falling ones. Two super-cycles prevailed in the 20th century, the first driven by post-World War II reconstruction and the second by oil supply shocks in the 1970s. Economists regard the latest one as having begun in 1997, triggered by double-digit growth in China and other emerging economies, ramped up biofuel production, speculative investing and climate-related disasters.
The question is whether the third super cycle already seen its best years or whether the current pullback is simply a long pause before demand returns and puts renewed upward pressure on prices. The argument for the long pause is that with nearly 9 billion people to feed on the earth, and seriously strained resources, commodity shortages are inevitably around the corner.
Hugh Peyman, director of the Shanghai-based financial research firm Research-Works, argues that “History shows a repeating trend of real prices rising for about a decade and falling for about two decades. In fact, nine years up and 19 years down is the actual average cycle since 1945, not very different from averages since 1865.”
Research-Works’ explanation is that “these long-term up cycles reflect the long-term investment cycle, which has three parts – underinvestment, overinvestment and market clearing. First there is a shortage due to under investment during the earlier period of falling prices as markets clear. Then there is an increase in investment which leads to over investment, brought on by attractively higher prices and profits. Finally, as this brings increased production onstream, so the increased supply pushes down prices.”
Peyman’s stock answer for shortages is to quote the economist Milton Friedman: The answer to high prices is higher prices. Underinvestment leads to overinvestment and finally market clearing. High prices stimulate supply.
Nowhere is that clearer in gold, which has seen a phenomenal runup in price over the past decade. With China and India demand weak, Peyman says, the average price has peaked in 2012 and is likely to continue lackluster. The gold bugs pushing gold may end up with investors chasing them for lost funds.
Friedman’s law particularly applies to the shale gas development boom, led by the US, to find alternatives to crude oil shortages, high prices and control over the resource by unstable Gulf countries. It is estimated that there are 173 billion tonnes of shale gas reserves in 32 countries worldwide against reserves of conventional crude of 206 billion tonnes. As Asia Sentinel reported on Oct. 16, by 2020 – just eight years from now -- the world will be producing 49 million more barrels per day of crude and natural gas liquids than it is today, with all of the attendant concerns over climate change growing ever more acute.
In a research paper prepared for the Seoul-based Samsung Economic Research Institute, those who say the cycle has run its course point to slower growth in China and technological advances in commodity development. The commodity bulls predict upward momentum will resume. They say China’s urbanization is not completed and that infrastructure in advanced countries needs to be repaired and modernized.
However, with outsized fiscal deficits in advanced countries, sluggish exports and declining domestic demand in emerging market economies slowing the global economy, SERI says, “no quick return to pre-crisis growth is expected soon.”
Global economic growth peaked in 2009. The long-term downward commodity price trend could well accelerate given the low growth of the global economy, with the Eurozone in a seemingly intractable recession and the United States seemingly about to slip back into. With China and Japan, these are the users of key industrial inputs, follow world economic growth by two to three years.
Several micro issues must be monitored closely, issues will shape the speed of price declines including shale gas, renewable energy, biofuel, China demand and climate abnormalities. “Each of these carries questions of their own about the magnitude of their impact, but there is no doubt they will be influential.”
China is the joker in the pack. Its rapid industrialization and urbanization since 2000 has led to insatiable demand for all types of commodities, the SERI report points out. “As of 2011, China consumes 49 percent of the world's coal, 40 percent of its copper and 26 percent of its soybeans, and will likely continue functioning as a “black hole,” though on a lower scale. Also, China's energy consumption per person was 1.9 tonnes in 2010 and is projected to rise to 2.7 tonnes in 2020. Higher meat consumption linked to China’s growing middle class already has made China a top importer of soybeans to feed livestock. China's corn imports in 2020 will be four times those in 2011, while soybean imports will increase by 160 percent.
Nonetheless, “Although various commodities may spike to new highs due to short-term events,” SERI says. “demand will continue to be weak.” The super cycle is likely over. Research-Works agrees.