How do you judge the current situation in the commodities market?
We are experiencing a generalised price increase of raw materials and semi-finished products, from agricultural products, to energy and industrial metals.
The three major product families show different dynamics and in some way the increases have different drivers, there may be important distinctions, but prices are record-breaking in all the main components of the basket. Although these are still synthetic indexes that should be analysed in detail, we can mention that the “energy” component has risen proportionally much more in the last three months than the “metals” and “agri” components, which have moved with a similar profile. Notwithstanding the due differentiation, it is all consequence of imbalance between supply and demand that has not been seen for years, so much so as to cause speculation that we are at the beginning of a so-called “supercycle”.
What are the reasons for this series of price increases? It is not just the fault of the pandemic…
Certainly not, in fact perhaps more “fault” of post-pandemic optimism. The fundamental element that leads to a price increase as pronounced as the one we are facing, is the presence of demand – actual or expected – that supply is unable to meet. As anticipated, the different commodity families follow different dynamics, it is however true that several events seem to have concentrated these years, to “prepare the ground”. We could mention: (i) last year’s floods in China and drought in parts of Latin America that have affected the availability of some agricultural products. (ii) the already very low levels of pre-covid industrial metal inventories, due to the industrial recession that most of mature economies were in, already during 2019. (iii) the further slowdown in production and consumption, combined with uncertainty during 2020, which has further reduced inventory levels.
As consequence, the post-covid recovery producing strong demand in most of the supply-chains has triggered a significant apparent demand – amplified by the need to restore stocks – accompanied by a slow recovery in production activities, hence low availability of supply.
Similarly, post-covid recovery forecasts have had an impact on energy, following the reduction of mining activity during the 2020s, when prices had fallen to economically unsustainable levels. You may recall the paradox of negative prices on oil…
For all sectors, we then add that logistics capacity, trivially shipping capacity, is given – adding new ships takes years and production plans are defined – so even if if we imagine, which is not the case in reality, that production and extraction capacities could be adjusted in a short time, logistics would become the bottleneck. In fact, we’ve also seen impressive surge in costs associated with shipping. An important cost component that ultimately affects the consumer price of finished products.
Which of the markets causes the most concern?
This question is difficult to answer, both in terms of geography and product. We are talking about commodities or essential goods, so by definition we should be concerned about all of them, because to some degree they all impact our lives
We might think that we could live a normal life without some products that we consider “accessory”, almost a fad like coffee or cocoa, but if we weigh up the matter in depth, we will realise how many economic activities are involved and depend in part on these products, how many companies depend on them – from production to the trade of finished products – making them extremely important for our economies and, consequently, for our lives.
In general, we could say that wherever there is geopolitical instability, there is concern.
There are those who hypothesise the imminent beginning of a so-called supercycle…what does that mean?
It is an open debate in the last months. Cyclicality is a typical, I would say genetic, characteristic of commodities, but a super-cycle occurs when commodities are traded for a rather long period – typically around a decade or more – at a price higher than medium-term trends, prior to the beginning of the positive cycle, which then becomes a “super-cycle”.
From the beginning of 1900 to today I think we can identify 4 super cycles: (i) at the beginning of the century, on the back of industrialisation and urbanisation of the United States, then continuing with the arms race of the First World War, with a peak around the end of the war, but ended with the crisis of 1930. (ii) starting from the Second World War with the need for materials dictated by war necessities, followed by the post-war period with the needs for reconstruction, lasting until 1960. (iii) a third cycle between the ’70s and ’80s, when economic growth highlighted in particular the limits of energy availability. (iv) and finally the early 2000s when the BRICS, especially China new member of the WTO, with their growth have contributed strong consumption of raw materials to support their economic development, until the global crisis of 2008 and for some products until 2014, when China reached the saturation of its market and reversed the trend by exporting the surplus, in combination with the surplus of global oil availability.
As you can see, these long cycles are often initiated by rather sudden events – mostly difficult to foresee reasonably in advance – that generated strong growth in demand to which the supply side could not respond as quickly.
Increasing mining capacity takes a long time, a mine takes years to get up to speed, not to mention the time needed to identify reserves. The same is true for plants producing semi-finished aluminium products or steel, which take years to build. And similarly we consider oil, gas, or agriculture. When demand remains steadily high, this time lag generates super cycles. When supply and logistics capacity finally adjust to satisfy the demand, prices stabilise.
It is natural that in regimes of low prices, general uncertainty and stable or even low demand – as in recent years – suppliers do not invest in expanding production, or extraction capacity. In some industries, there have even been closures of inefficient, or environmentally impactful, plants without the lost capacity being replaced by more modern facilities. There was simply no need.
The post-covid momentum, expectations for widespread investment plans and declared modernisation strategies in terms of energy efficiency and sustainability, generated a sudden need that, in combination with low inventory levels, immediately spilled over upstream, where supply capacity is clearly insufficient, with two consequences: 1) price growth 2) shortage of immediate available goods, with planning for the availability of required products, far into the future.
However, whether this is a prelude to a super-cycle has yet to be demonstrated. In reality, we will find out as we live. Part of the apparent low supply is dictated by low initial stock levels, the demand related to the need to restore stocks to normal levels is an important component of the current apparent demand, when this will be satisfied, we will have to see where the real demand levels will settle. Similarly, part of the reduced supply was dictated by the containment plans for covid – less hours worked, plants shut down slowly re-starting operations – the return to normal and the return of production facilities to full capacity will satisfy some of the peak demand in a reasonably short time. Basically, the reaction on the supply side could be rapid, at least to cover part of the apparent demand.
On the other hand, in the medium-long term, we can imagine that all stimulus and investment measures that states are implementing will remain, in combination with relatively low interest rates and the wave of investments linked to sustainability. If the combination of these elements prevails, it is not excluded that we will see a super-cycle.
What would be the consequences of a super-cycle?
Natural consequences are the engine of a healthy ecosystem. Higher prices generate margins that producers can re-invest in research and expansion of production capacity, thus re-balancing the supply/demand relationship, generating and redistributing economic value with all parties involved in the projects.
The shortage of supply also leads to the search for substitutes, or more efficient production models, along the various supply chains. Opportunities are created for sometimes disruptive innovations, new economic initiatives are born, and healthy competition based on the creation of lasting value is nurtured.
Basically, it is a flywheel for societies – and this is demonstrated by the 4 cases cited – historically it greatly supports economic and social development. It is no coincidence that the composite index of the price of “non-oil” raw materials moves in a synchronized manner with respect to global gross domestic product. This has been a fact since the end of the 19th century.