If you have been reading about commodities, chances are you read about a supercycle. Every major financial news has covered it many times in the past year or so. You probably read conflicting views in relation to commodities: “supercycle might be over,” “supercycle death is premature,” “supercycle is not real” or “maybe the supercycle is real.” There not only is disagreement on whether it is real or not, but also on the length of a supercycle. You can almost always trust economists and market analysts to not agree with each other. Expect them to present opposing theories supported by the most convincing data possible.
So why is everyone suddenly talking about commodities supercycles? And why should you care?
Why Talk About It Now?
The chatter about a supercycle wasn’t pulled out of thin air. You probably read more about it because of the consistent slump in commodity prices for the last 18 months. The supercycle debate has been raging for about 100 years now. It has been particularly relevant in the last year or so. After being range bound between $100 to $120 for three years, oil prices started on a path of sharp correction last year. Before this happened, there was hope this was a continuation of a bull cycle that started in the late ‘90s (drawn as a dotted breakout arrow in the chart below). However, it went south, and now we are well and truly in a downward trend. In fact, we are pretty close to where we were at the worst of the 2008 crisis. The shock is lower this time because the correction is as sudden, and the financial markets haven’t behaved as badly as they did at that time.
What Are These Supercycles?
In the early 19th century, Nikolai Kondratiev got the international community to turn and pay attention to a theory of economic cycles that had brewing for some time. The traditional view at that time was the cycles lasted for 50 to 60 years. Gradually, this theory became a hotly debated topic, and various economists challenged its characteristics over the years. They have cited proof that the cycles don’t have to be that long and can last for just 10 to 30 years. It is important to note the rate of innovation and technology adoption has changed drastically in the last 50 to 100 years – so cycles might be shortening, for all you know.
In recent times, two renowned economists attempted to describe the supercycles in 2002. They published a paper (still on the UN website) using newer statistical techniques. They concluded there were four major cycles in the last 110 years (1894-2010). The first one obviously peaked prior to 1920 and ended with the Great Depression. The second peaked in the 1950s and ended in 1971. The third one started right after and ended in the late ’90s. Now, the most interesting part of their findings was their theory about the current supercycle. Per their analysis, it started in the late ’90s and already peaked in 2010. Given they studied data only until 2010, they couldn’t have known what happened between 2010 and 2014, when prices recovered a little bit then stayed range bound for three years. Either way, it turns out they were right, because two years after they published the paper, commodity prices fell by 40% to 50%.
What Does It Mean for Investors?
Irrespective of how long or short the supercycles might be, these cycles go through some distinct phases: expansion, contraction and recovery (metrics of measurement could be GDP, level of employment). If we are past the expansion phase, we should be in contraction phase. If current commodity prices are any indication, contraction phase makes a lot of sense. Given below are some charts taken from IMF’s Special Commodity Feature published in October 2015.
If we are in contraction phase, the most important question is how far into the contraction phase are we? A contraction cycle is not all that bad, because it is followed up by a recovery phase. The reason for that is the supply side of business starts to cut down its production to cover losses coming from falling commodity prices. Along with that, the low prices encourage new development – and that means fresh demand. It is a matter of time before the higher demand and/or the lower supply starts to boost the prices.
The Bottom Line
Studying business cycles gives a good macro perspective on where the industry might be headed. Along with fundamental and technical analysis, it gives a much richer and complete view of future. It may not be a bad idea to watch out for critical resistance levels in the coming months. If the prices bounce upward a few times from those levels, it might indicate we are closer to the end of contraction phase – or it breaks out in the other direction; then we are looking at a further heavy decline. Related reading: Are We Being Too Pessimistic About Commodity Prices?
Note: Investment decisions based on purely macroeconomic factors is not a good idea. They serve like guidelines rather than investment signals. You shouldn’t make investment decisions without studying fundamentals of the sector in which you want to invest – which means analyzing producers, buyers, distributors etc. relevant to that sector. That holds good even if you are not taking a position in any company from that sector but in the commodity itself.
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