What does a flagging commodities supercycle mean for the investor?

Rather than wonder if the supercycle has ended, keep watching for confirmations of continuity, or signs of reversal

Ravi Ananthanarayanan
Updated20 May 2013, 08:38 PM IST
China&#8217;s seeming ability to turn on high growth rates, as it did for many years before it scaled it down, can be a surprise factor. If its growth is now linked to how the global economy does, then the outlook for commodities does not appear rosy. Photo: Mint<br />
China&#8217;s seeming ability to turn on high growth rates, as it did for many years before it scaled it down, can be a surprise factor. If its growth is now linked to how the global economy does, then the outlook for commodities does not appear rosy. Photo: Mint(Mint)

From an Indian investor’s viewpoint, the debate on whether the supercycle of commodities has ended is relevant for several reasons. A declining trend in commodity prices can take the edge off rising inflation. It not only makes life less expensive for a consumer, but also ensures the Reserve Bank of India can stay the course on cutting interest rates. If the government gets its fiscal act together, all these factors can combine to get growth back on track. That’s the big picture. But falling commodity prices are a double-edged sword because India’s basic industries will earn less, affecting earnings, valuations and eventually growth.

add_main_imageWhy is there so much talk now about the commodity supercycle having peaked? The debate is not new, but it would seem the voices are becoming louder. As commodity after commodity has lost favour, it has become difficult not to agree that the supercycle may have indeed peaked.

But can we say that for sure? First let’s see what a supercycle is. A February 2012 United Nations department of economic and social affairs working paper, Super-cycles of commodity prices since the mid-nineteenth century, talks about four past supercycles lasting from 30-40 years (1894-1932, 1932-1971, 1971-1999 and the current one since 2000). Non-oil prices tend to follow world gross domestic product, says the paper, indicating that they are determined by demand. What is critical here is that even at the lower end of the range, a supercycle has been seen to last for 30 years. The current one has many years to go before it reaches that mark.NextMAds

What is definitely visible at this juncture is a change in the global economic situation, where demand for commodities has weakened. Flagging economic growth in the much-feted emerging economies, especially in China, a large consumer of commodities, has upset prices. Fresh capacity had been created to cater to the supposedly insatiable appetite for commodities from these economies.

Coming back to the supercycle, one school of thought says demand for commodities has peaked. Rather than a tide that lifts all commodities, individual demand-supply conditions will now play a bigger role in determining commodity price movements. Another school believes current signs point to a pause rather than a crash. The rising cost of production means producers will cut capacity, correcting excess supply conditions, and eventually prices will recover. This school also believes the fundamental nature of emerging economies has not changed yet, and it is only a matter of time before demand springs back.

The central player in all these arguments is China. Its seeming ability to turn on high growth rates, as it did for many years before it scaled it down, can be a surprise factor. If its growth is now linked to how the global economy does, then the outlook for commodities does not appear rosy. In that case, one can say that the supercycle may have indeed peaked because it is doubtful if any region or country can equal China’s impact on the world of commodities. But if the government decides it’s time for growth to come back to earlier levels, it may well force everybody to rework their calculations.

Rather than wonder if the supercycle has ended—a question for which there are no easy answers—investors may find it makes more sense to accept the current trend and keep watching for confirmations that it will continue, or signs that it may reverse. A pullback in economic growth indicators in some of the resource-hungry countries and regions could be one sign. An unforeseen global event that leads to a liquidity gush into commodities is another. These factors could cause a reversal in the pessimistic outlook for commodities. Till then, there may be only isolated instances of commodities bucking the general downtrend.

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First Published:20 May 2013, 08:38 PM IST
Business NewsMarketMark-to-marketWhat does a flagging commodities supercycle mean for the investor?

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