In today’s Exponential Investor…
- Know your shocks
- One commodity tanks, another buffers the worst
- We’ve got WiFi, yet some people can’t turn on a light
Commodity supercycles are odd things.
For starters, how many we’ve actually seen depends on the analyst. Plus, they really don’t happen all that often. You might live through two, but only get to invest in one.
To boot, they have a habit on sneaking on up us. The signals that a supercycle is underway aren’t always clear at the time.
However, all commodity supercycles have one thing in common, and that’s a demand shock.
Behind every boom is a shock
A commodity demand shock can be anything.
An earthquake, government financial incentives or disruptive weather events, for example. Or, in the case of lumber, income-secure people being stuck indoors and deciding to renovate, rather than spend their money on holidays…
All of these can trigger a sudden surge for a commodity. When this happens, it’s called a commodity supply shock. More people unexpectedly want the same thing, and prices rise to reflect the change in demand.
However, when these supply shocks occur, they are unlikely to have a meaningful impact on supply. Over the short run, the supply of a particular commodity will be tight, but not enough to convince anyone that there are significant changes in quantity available.
Depending on the timber, it can take five years for an increase in supply for the lumber market. Whereas a mine can take between 12 to 15 years to boost supply.
A timber plantation isn’t going to grow more lumber trees because of a short-term surge in bathroom renovations. Nor is a copper mine going to open a new pit because there’s a run on kitchen gadgets.
A sudden desire among the population to redo the bathroom or kitchen during lockdown isn’t going to persuade a plantation farmer or a copper miner to invest millions upon millions for now.
Then, there’s the aggregate demand shock. This shock is the unexpected increase in commodity demand thanks to rapid industrialisation. The sort of shock that sees persistent demand eventually trigger further investment in expanding commodity production.
The kind of investment that last for years, not months
The problem is that understanding a structural shift in demand versus a temporary supply problem isn’t always clear cut. Primary producers – the very companies that bring us the commodities we need – don’t always have obvious signals.
Again, let’s take lumber for example.
The price of lumber in the US has seen three price surges since the pandemic began. Yet its price has now almost fallen back to the pre-pandemic level.
Lumber has had three prices peaks since the pandemic began (USD)
Source: Trading Economics
With interest rates rising and what may be a property slowdown in the US, lumber has merely experienced a “commodity demand shock”.
Copper, on the other hand, may be facing an “aggregate demand shock”. While its spot price has fallen in tandem with China’s economic slowdown, it’s still well above its pre-pandemic price.
Spot copper price remains high per pound (USD)
Source: Trading Economics
Copper is still holding up well despite concerns of a broader economic slowdown, perhaps telling us that demand for this metal is secular after all.
Inflation threat or once-in-a-lifetime opportunity?
As global markets are hit, many commodities are taking a trip down with them.
It’s enough to question whether the exciting commodity price rise of 2021 is now just the dud investment of 2022.
While I agree that commodities investing today is difficult, the aggregate demand shock for natural resources is still to come.
As I wrote yesterday, there can be almost a decade-long lag between a surge in demand and getting the stuff out of the ground.
That’s just part of the picture.
Sure, today, major economies are faced with increasing inflation and threats of stagflation, but if we overlook commodities, we are at risk of ignoring perhaps the greatest “get-in-on-the-ground” investment opportunity since the dotcom era.
The story isn’t obvious now, but there is an undercurrent lifting commodities higher.
The Western world is facing a green revolution while butting up with the industrialisation in emerging economies. This demand is being squeezed on three different sides: a tougher regulatory environment, geopolitical fault lines, and a drastic underinvestment in the resources needed to meet this synchronised commodities growth.
Leaving investors with an unequal formula where one part of the globe is going carbon neutral while the other is being electrified.
It’s easy for people like you or I, who have a house full of stainless steel and everything connected to WiFi, to forget that 13% of world still can’t turn a light on.
This demand for building blocks of electrification is going to catch investors off guard when miners can’t supply what’s needed.
What it leaves us with is a metals-focused super cycle…
Stay tuned, investors, and we’ll dig into that tomorrow.
Co-editor, Exponential Investor