Supercycle? Maybe, but investors should eye the long game

The recent run-up in commodity prices has unsurprisingly spurred discussions about a newly emerging commodity supercycle. It's clear we are in the midst of a supply-constraint-led boom, but this does not portend a longterm trend or decades-long supercycle ahead.

Indeed, any outlook of the sort that depends on a Roaring Twenties narrative, where global economies surge back to life once the pandemic is behind us, needs to be taken with a huge grain of salt. However, we do see secular changes arising such as China's increasing dominance and India's rise (part of our “Go East” theme), as well as the global shift toward electrification creating opportunities for investors within a certain class of rising commodities.

Boom/bust cycles in commodities are historically pervasive events, typically lasting relatively short periods (three to four years), as can be gleaned from the Commodity Research Bureau index. Bear markets typically see the year-over-year negative trend bottom out at -15 per cent; the trend for bull markets peaks around 24 per cent.

If history is any indication, we are still in the first third of this bull phase in commodities in terms of duration and the first half in terms of magnitude. But given the distortionary effects of the pandemic lockdowns on supply chains, it's also very possible that we will see a much shorter boom this year followed by a bust in 2022.

The major risk ahead for this current upswing in the cycle is a slower-than-anticipated recovery in global economic activity. The United States, for example, is staring down structurally higher levels of unemployment and elevated precautionary savings coming out of the pandemic. But once the government stimulus has run its course and the pent-up demand story is shown to be a fabulous fable, the risk of a renewed recession next year could stop the commodity surge in its tracks.

That said, there are longer-term structural changes that could result in an enduring boom once the COVID-19 distortions and recession risks are behind us. The first, of course, is China, which was one of the key drivers of the commodity supercycle in the early 2000s with its massive infrastructure and urbanization agenda, and which has emerged from the pandemic on solid footing — managing to grow by 2.3 per cent in 2020 while the rest of the world contracted.

India, meanwhile, continues to be a major market to watch over the coming decade, not only because of its young and growing population, but because of the opportunities for investments in infrastructure and technology that will help transform the nation into a formidable counter-power to China's ambitions. It is also a strategic partner for the energy transition ahead.

If either of these countries embarks on a sustained growth path over the next few years, it would serve as a massive tailwind behind commodities of all stripes. Even if a broad-based commodity supercycle doesn't materialize, there are certain key metals and minerals such as lithium, cobalt, graphite, rare earth metals, silver, platinum, copper and nickel (to name a few) that will see a huge surge in demand ahead as countries push forward with ambitious “build back better” campaigns centred on electrification, green infrastructure, transitioning to electric vehicles and so on.

The pandemic-induced economic hole that much of the world is digging out of has made this an even more urgent priority, which is accelerating the adoption of technology and leading to supply bottlenecks for important components such as semiconductors, as we've recently seen. Underinvestment over the past decade means that certain commodities like copper are facing an estimated 500,000-ton deficit in the face of increased demand. Lithium demand is expected to triple by 2025 and 10-fold by 2030. Indeed, in the wake of these issues, U.S. President Joe Biden has announced a supply chain review will be carried out to identify ways to guarantee access to things such as semiconductors, rare earth minerals and other components of EV lithium-ion batteries.

Despite the name, rare earth minerals (used in electronics, clean energy and defence tech) are quite common, though fully 35 per cent of global reserves and 63 per cent of production are located in China. The U.S. share of production is approximately 12 per cent, while its share of known reserves is only one per cent (1.4 million tons). If the U.S. hopes to secure supplies of many of the key commodities required for the energy transition ahead, it will need to rely on partners such as Australia, Chile, India and Brazil that have significant reserves of rare earths, lithium, cobalt and graphite.

This is yet another argument for closer ties with India: the country is home to six per cent of global rare earth deposits, but its production is an underwhelming 1.4 per cent, meaning there are opportunities to engage in resource-diplomacy with the country in an effort to counter China and Russia's commodity dominance.

All told, we don't see the current commodities surge as the start of a new supercycle, but there are demand pressures ahead, once the pandemic is squarely behind us, that will guarantee a need for upstream investment in critical commodities. Luckily for the U.S. and others, there are significant reserves in traditional partner economies such as Australia and opportunities to strengthen ties with India and Latin American producers, all of which stand to benefit from the global shift to electrification and green technology.