Pedal to the metal

The limp performance of metals and bulk commodities over the past couple of years has resembled a unicycle rather than the superbike of previous years. According to Simon Wright of The Economist, the 2014 outlook for demand is rosier and commodity prices should start climbing once again.

By

This article explains why the commodities “supercycle” driven by China isn’t at an end just yet. In fact, things are looking rosy for 2014.

Commodities are a cyclical business. And the limp performance of metals and the bulk commodities (iron ore and coal) over the past couple of years has resembled a unicycle rather than the superbike of the preceding years.

Growth has slowed in China, the destination of most of the world’s exports of iron ore, copper and other metals, as well as increasing quantities of oil and corn. Many analysts have declared that the China-driven commodities ‘supercycle’ has run out of road. That may be premature.

There are reasons to think that in 2014 and beyond the demand doomsayers will have to rethink their downbeat assessment of the resources the world will require. And forecasters predicting that the supply side will be inundated by new projects, spurred by the high prices of recent years, could also find that the glut is not quite as vast as expected. In 2014 commodity prices should start climbing once again.

Prices were volatile in 2013 but ended the year little changed, with falls in metals and agriculture offset by higher prices in energy. And prices are still high compared with the last two decades of the 20th century: in real terms commodities change hands for double what they fetched in the 1990s.

As HSBC points out, those who suggest that commodity prices will revert to the mean need to identify where that mean is. Prices were exceptionally low in the 1990s. Excluding oil, they are now at the level of the mid-1970s and are below where they were for much of the first half of the 20th century. Judged by the broader sweep of history, prices are not abnormally elevated.

The pre-millennium lull occurred because the rich world had passed its resource-intense period of growth – many of the bridges, motorways and cities had been built. Investment dwindled. Commodities producers were not prepared for the huge and unprecedented impact on resource demand of China’s rural poor moving to its cities.

But what will happen to demand now that China has applied the brakes? Demography has a big influence on commodity consumption. Though global population growth is slowing, the total number of people added each year is still growing.

Similarly, China’s economy will be 65 percent bigger in 2014 than it was in 2008 and overall demand will grow much more than in past years in tonnage terms even as the rate of growth slows. Macquarie, a bank, reckons that the growth of global demand for steel will slip to 3.1 percent a year between 2012 and 2018, compared with 3.3 percent in the previous six-year period, but that in absolute terms it will go from 45 million tonnes a year to 50 million tonnes a year. The same trend will apply to copper, aluminium, nickel, lead, zinc and tin.

In terms of its impact on demand, Chinese growth of 7.5 percent today is the equivalent of 12 percent growth in 2008. Moreover, the process of urbanisation, and the commodity-hungry infrastructure and housing required, is far from over. On top of this there is the growth of other Asian countries, such as Indonesia, Vietnam and Thailand, and the recovery of the American economy (still a big consumer of resources).

Even India, a small importer of commodities, might overcome its chronic inability to reform its economy and start a mass migration of its rural poor to cities sometime in the next decade. All this adds up to a rosy outlook for demand.

The spoke in the wheel of the cycle is that the rise of commodity prices over the past decade has led to a splurge of investment by mining and energy companies. The time lag for the huge, capital-hungry mining projects started in the boom means that new supply is arriving and more is on the cards. Yet the upswing in investment is over and from 2014 the world’s mining giants will cut investment dramatically.

All this suggests that prices are at or close to the bottom of the cycle. The pace may not match the multi-cylindered road-rocket of yesteryear, but the next upward climb looks set to start in 2014.

This article was written by Simon Wright and first published for The Economist.

From The World In 2014 magazine, © 2013 The Economist Newspaper Limited.  All rights reserved.

More information: