Is there a new commodities super-cycle?

Commodities enjoyed a super-cycle during the first decade of the 21st century. Huge demand from emerging markets, and China in particular, caused a sustained increase in prices.

Then China’s economy started slowing and the cycle came to an abrupt halt in 2011. The industry, which had massively over expanded during the boom, subsequently fell into a sustained bear market, which didn’t bottom until 2016. Since then, the asset class has remained very much out of favour.

But this year, commodities seem to be back in vogue. And Schroders’ head of commodities, James Luke, says there are five reasons to believe in a new commodities super-cycle to about to begin: commodities valuations are cheap; inflation is on the way; demand for commodities is set accelerate; underinvestment always precedes the next commodity cycle; and the US dollar is expected to depreciate in the coming years.

“We see several structural similarities between the early 2020s and the early 2000s,” he said. “Now, as then, we have seen significant underinvestment in commodity supply. In the early 2000s, China represented a major source of accelerating commodity demand. Today, we may be about to embark upon an unprecedented period of co-ordinated global capital investment to facilitate the energy transition.”

Metals in particular are essential to ensuring the energy transition and the move to a low carbon economy takes place. For example, wind turbines need iron ore, solar panels require silver. Similarly, electric wiring for electric cars requires copper, and batteries to store power need lithium.

But while there are clearly some structural growth stories for the asset class, are we actually entering a new super-cycle?

Dr Niall O’Connor, manager of Brooks Macdonald Defensive Capital, says it is a possibility. “The fundamentals are certainly there for a new super-cycle,” he said. “Investment and capital expenditure has been extremely low for a long time, inventories are incredibly low everywhere you look, and this, in combination with a re-opening of economies and huge stimulus, is driving up prices.”

John Stopford, co-manager, of Ninety One Cautious Managed fund, is also positive. “Over the longer-term, there is clearly a positive story for commodities, driven by a powerful combination of government infrastructure stimulus in the West and renewable infrastructure globally, which is required to support decarbonisation,” he commented. “However, it is too early to say whether the recent rise in commodity prices is due to restocking across major economies as demand comes back online, or something more structural.

David Coombs, co-manager of Rathbone Strategic Growth Portfolio, is not convinced. “I think we are going to see economic activity moving back to normal over the next 18 months so there will be some inventory drawdown and rebuilding,” he said. “So maybe we’re having a ‘mini-super-cycle’, but I think it is far too early to extrapolate that into anticipating a multi-year super-cycle.”

Which commodities do you like and why?

Commodities come in all shapes and sizes and include precious metals, industrial metals and agricultural products like wheat and corn.

So we asked all three managers which commodities they current like and dislike.

John Stopford, co-manager, Ninety One Cautious Managed fund

“We continue to like iron ore and steel, as well as copper. Whilst we think commodities are potentially overbought in the short-term, the average price forecast for this year is, in our opinion, too low. All three metals mentioned will be useful in the long-term infrastructure spend.

“We continue to like precious metals too, such as gold and silver, and expect them to perform well over the next 2-3 years due to repercussions from the pandemic and the unprecedented levels of stimulus that we have seen and continue to see.

“On the other hand, changes in battery technology will impact nickel demand but it is unclear how, whilst the development of nickel pig iron facilities in Indonesia means the outlook for supply is also very uncertain.

“The outlook for oil prices has improved with the approval of vaccines in North America and Europe supporting expectations of stronger demand in 2021, whilst Saudi Arabia’s unilateral decision in early January to cut supply surprised the market and provided further support short term. However, the longer-term outlook remains uncertain. OPEC now has unprecedented levels of spare capacity to bring on as demand improves and accelerating electric-vehicle adoption rates threaten demand forecasts in the medium term.”

Dr Niall O’Connor, manager, Brooks Macdonald Defensive Capital

“Oil looks to have the most interesting combination of long-term under-investment, a cyclical demand upswing, and also a slightly contrarian play due to the electric vehicle equity bubble.

“Gold is a different story, as prices have been high for some time. Almost all gold miners are profitable and there has been no shortage of capex. Gold has traditionally been seen as an inflation hedge, but over the last few years this hasn’t been the case and it behaves more as a hedge against real interest rates, rising when real interest rates fall.

“Thermal coal is difficult to like from an ESG perspective, especially as cleaner alternative sources of energy are available. Coking coal (which has no alternative if you want to make steel) looks a better bet. Anglo Pacific Group has a coking coal royalty stream, for example.”

David Coombs, co-manager, Rathbone Strategic Growth Portfolio

“I want to hold those linked to economic growth, specifically soft commodities, energy and industrial metals. These form part of my inflation hedge.”

“I don’t like precious metals and we sold all of our gold in portfolio very recently. While our view on inflation remains sanguine, we recognise inflationary fears are rising and may well continue to do so until late into the third quarter of this year as economies re-open. In view of this, we feel the risk to the upside in bond yields is far greater than the downside.

“This is not a good backdrop for gold in the short term and, given its lack of yield, it is always difficult to identify fair value. This means when momentum shifts it can see significant drops in price. In addition, momentum in the pound has been strong up until recently, possibly driven by the success of the vaccine programme but also due to its valuation post EU referendum. This could continue and act as another headwind for gold in Sterling terms. We may well reinvest towards the end of the year as we still believe inflation will be low for the next decade.”