The investment industry’s drums have been beating about a coming commodities supercycle since the end of 2020, but now the indicators are getting really hard to ignore.
Here is a succinct primer to help investors get a handle on the key issues.
What is a commodities supercycle, and how frequent are they?
Firstly, it is worth recapping that the commodities asset class is highly diverse, including both “soft” commodities that are grown or reared (like coffee, wheat, and livestock) and “hard” commodities that are mined (like oil and metals). It is hard commodities that are the focus here.
A supercycle is an extended price boom and there have only been four in the past century. The last one in the early noughties was driven by the rapid growth of the BRIC economies of Brazil, Russia, India and - in particular - China and a resulting supply-demand imbalance for the materials required for huge infrastructure projects.
What are the signs a supercycle is coming?
Soaring commodity markets are now very much in view. Cobalt and nickel have bounced back to pre-pandemic highs, while copper and iron have hit prices last seen nine or ten years ago. Oil has resurged to pre-COVID levels – a far cry from it slipping into negative territory for the first time ever last spring as global demand plummeted.
A lot of confidence is manifesting, not only in commodities themselves, but also all the associated mining and supply chain stocks.
What are the drivers of this potential supercycle?
Advocates of this investment story cite several interlocking factors.
First is the pent-up demand that is going to be unleashed when lockdowns are lifted. This will combine with massive stimulus programmes in major nations, which are very much orientated towards the green agenda.
Solar panels, wind farms and electric cars rely on commodities like cobalt, nickel, copper and “rare earths”, while electricity storage calls for massive infrastructure upgrades too.
Ironically, it is likely to be some time before the extraction of metals and rare earths is green itself, so the clamour for green energy is set to result in a thirst for the brown stuff.
This and supply issues due to falling investment mean that oil is likely to soar – some say to double or triple its current value, and enough to serve a serious economic shock to the world.
Finally, there is the fact that commodities are mainly priced in US dollars and the dollar’s recent fall in value has boosted the prices of commodities.
Is it all upside?
Commodities are a highly esoteric area at the best of times. There are some particularly complex themes bound up in the supercycle story and it remains to be seen how all the drivers will play out.
Take oil, for example. It is worth noting that oil producing nations will be desperate not to see prices soar beyond a tipping point that would make abandoning oil the cheaper option.
More broadly, the hoped-for “roaring twenties” could be stymied by mass unemployment or the green revolution may take longer than we imagine. We have a very long way to go in the transition to electric cars, let alone planes, and the bulk of fossil fuels are used for aviation.
What should investors do?
A commodities supercycle holds lots of opportunity, and allocating more to alternatives might be a good move to improve diversification and (hopefully) enhance returns. Commodities are generally thought to be a good hedge against inflation due to them being pretty well correlated. Meanwhile, an inverse correlation with traditional assets helps defend against volatility.
A sensible allocation to alternatives is unlikely to be large for anyone but the Ultra High Net Worth Investor; massively overweighting commodities at the expense of traditional stocks and bonds is not a sensible play here – any more than sinking all your wealth into a virtual handful of Bitcoin would be.
The name of the game, as ever, is getting the most reward available for the level of risk you are comfortable with and able to afford. By all means, look to play the commodities supercycle, but remember not to be overly credulous when assessing this or any other investment theme.