There’s more to soaring commodity prices than the post-Covid rebound
Commodity prices are bouncing back in anticipation of a post-Covid surge in demand. Add existing supply shortages and the threat of inflation, and the future looks bright for raw materials, says John Stepek.
The idea of a new commodities supercycle is coming dangerously close to being a consensus viewpoint. Investment bank JP Morgan is the latest to join the fray, following hot on the heels of Goldman Sachs (among others).
And yet, it’s hard to argue with the rationale. Indeed, we’ve been talking about it here at MoneyWeek for a while now. So what’s the story? And how can you profit from it?
Raw materials prices are bouncing back for obvious reasons
The oil price has been on a tear this week, with Brent crude poking its head back above $60 a barrel. But it’s far from the only commodity that’s showing signs of recovery.
Platinum hit a six-year high yesterday. After years of being in the doldrums following the “diesel isn’t as green as the government and a certain German car maker told you” scandal in 2015, the metal is finally playing catch-up with the gold price. It still has quite a way to go before it gets back to its more typical position of being worth more than gold, but it’s starting to look as though it might get there.
Again, platinum is not alone. Copper was rallying yesterday too and has enjoyed one of the most aggressive uptrends since bottoming out during the worst of the initial coronavirus outbreak. Agricultural commodities are soaring too (which is bad news for food prices and social stability, but we’ll discuss that another day).
There are obvious reasons for raw materials prices to be bouncing back – we just shut the global economy down for the best part of a year; demand collapsed and so did prices. Now, there’s light at the end of the tunnel (although listening to government announcements, you might not think it), so it makes sense that prices would rebound – we’re going to be using the stuff again.
Of course, that’s helped by the fact that China started to reopen earlier and it’s been reflating its own economy by doing what it typically does – ramping up investment and building.
However, it’s not just about the battering from the pandemic. You have to remember that prior to the pandemic, the commodities sector had suffered a long bear market. That began in May 2011 – I think it’s fair to describe that as the peak of the previous "supercycle". (Others say it peaked in 2008 but if you look at the post-2008 recovery, I think you can consider that an interruption – 2011 is when it really hit the wall).
How commodity cycles work
The thing with commodities is that supply and demand tend to lag each other more than you’d see in lots of other industries. Long story short, it takes ages to build a mine. If metal prices go up, miners might want to take advantage, but it’ll take a while to turn that hole in the ground into something that’s producing a saleable product in the form of actual metals. So what happens is that prices keep going up because demand outstrips supply.
Of course, as prices go up, more and more miners want a piece of the action; they dig more and more holes. Eventually, those holes turn into mines, and because so many of them were dug, you end up with oversupply – particularly if the economic cycle happens to turn at the same time and demand drops.
Prices dive. Miners stop digging holes. They might even fill some of the existing ones in. Eventually, supply falls behind demand again, and prices tick higher, and the whole cycle starts over again. That’s roughly where we are now. 2011 marked the peak; somewhere after that – probably about 2014 – commodity producers threw in the towel in terms of investing in new production. In 2016, the bear market bottomed out, but recovery was intermittent. There was a bit of a comeback and then coronavirus hit.
So we’re at a stage where supply needs to expand to catch up with demand still. And then on top of that, we’ve got all sorts of promises about new infrastructure spending, combined with bottlenecks that have been created by coronavirus choking off key parts of the supply chain.
I don’t know if it adds up to another “supercycle” – which is a bit of a meaningless term, really. But if you believe that inflation is going to be an issue in the near future (and we do) then commodities are one of the few asset classes that can handle inflation when it starts to get out of hand.
We’ve looked at ways to play a new commodities boom in MoneyWeek in recent issues (I wrote about it here) and Merryn wrote about it earlier this week – but we’ll have a lot more in future issues. If you’re not already a subscriber, get your first six issues free here.