Commodities and capitulation
There’s nothing like a bit of long-term perspective to put things into context. The chart below is the IMF’s Commodities Index going back 23 years.
IMF Commodities Index
The first thing we would point out is that we are not commodities experts, so these comments are from the standpoint of an interested observer. Mind you, the track record of experts’ forecasts in the commodities space beggars belief that they can still be called experts!
A first observation is that before China began to seriously ramp up its industrialization program (China boom Mk I), commodities prices traded in a fairly restricted range. The effects of China’s urbanization program on commodities demand were obviously profound: that’s going to happen when more than 20 million people move from the countryside into cities every year for more than 10 years and they have to be housed, have work places and be able to get to and from them. Just think about that: it’s the equivalent of having to build five Melbournes every year from scratch. One mind blowing estimate is that in the three years to 2013 China used 40% more cement than the US did in the entire 20thcentury, so you can presume the amount of steel and what have you wouldn’t be too different. In fact steel production in China this year was estimated at 823 million tonnes; between them, the US, Japan and Russia never got close to 200 million tonnes.
The second observation is that the period of growth after the GFC (marked above as China boom Mk II) was after the government launched an economic package equivalent to about 6% of GDP aimed almost entirely at investment. That would be the equivalent of Australia launching well over $100 billion worth of construction programs today. That boom in Chinese demand saw a huge increase in commodities production capacity across the world. For example, iron ore supply more than doubled between 2000-2014, an annualised growth rate of more than 6%. The problem is, that rate of increase in demand was never going to last for ever, despite all that talk of the commodities ‘super cycle’, and now overall global economic growth is about half of what that growth is supply has been. In other words, there was a massive structural shift in demand for commodities, supply responded thinking it was a permanent change, but it wasn’t and now we have an oversupply.
And as we’ve written many times before, the composition of China’s economic growth is changing: the government is engineering a deliberate shift toward consumer spending to drive growth rather than fixed asset investment. Moreover, this year marked the first time the number of people moving to the city from the country didn’t grow. All of that means a slowdown in the rate of growth of China’s commodities demand, just at a time when growth in the rest of the world is also very low.
Reversion to mean is one of the immutable laws of financial markets. It is possible that’s what we’re seeing in the commodities space: reversion to a time when commodities prices traded in a fairly restricted range.
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