commodities

A commodities supercycle or boom is a period of sustained and continued expansion due to increased demand for goods and products. Such supercycles are driven by economic growth and demand for energy sources, manufactured materials, and raw materials.

In-Demand Commodities during a Supercycle

Commodities that are in high demand include natural gas, coal, crude oil, aluminum, copper, and iron ore.

Natural Gas and Oil

Natural gas is used to manufacture iron, steel, bricks, glass, and paper. It is also used by utilities companies for electricity generation and by the commercial sector for metals preheating, incineration, and waste treatment. Crude oil is refined to produce diesel, jet fuel, and gasoline which are used to power equipment and for transportation.

Global political tensions, conflicts, and sanctions as in the case of the Russia/Ukraine conflict push up natural gas and oil prices. Gas prices have already doubled while oil prices have recently reached $139 a barrel, the highest we have seen in about 14 years.

Russia is the world’s biggest exporter of natural gas and the second biggest crude oil exporter. If one country relies on Russia for gas and receives less, it has to find an alternative source, thus impacting supply elsewhere.

Industrial Metals

Coal is used by steelmakers to produce steel and by utilities companies to generate electricity. Aluminum is a key component of airplane parts, electrical transmission lines, window frames, and other goods. Copper is used as a construction material for plumbing and roofing and for the manufacturing of industrial machinery and electrical equipment. Iron ore has many applications such as manufacturing catalysts, auto parts, magnets, and steels and construction of bridges and commercial buildings.

Demand for industrial metals has been high during all commodities supercycles. In 2008, for example, China’s demand for industrial metals, including aluminum, coal, and steel, resulted in record-high prices in 2008 and kept prices on the rise until 2014.

When it comes to precious metals, we have seen an increasing demand for silver and gold. Commodity supercycles have no effect on the industrial use of specialty metals but they become more attractive as an investment tool and a hedge against inflationary pressures.

Why Commodity Supercycles Occur

Commodity supercycles occur in response to profound changes in how societies and economies function. Such changes increase demand for a wide range of commodities. History has witnessed 4 supercycles over the past 120 years. The first such cycle occurred during the US mass industrialization in the 1890s and continued until 1918, driven by an increased demand for weapons and armaments during World War 1. The most recent commodities supercycle occurred in 2001, with China joining the World Trade Organization. China’s large-scale urbanization and economic reforms increased demand for commodities. The fourth supercycle ended with the onset of the global financial crisis in 2008.

New Supercycle on the Horizon

There are some signs that we are witnessing a fifth supercycle driven by the energy transition and global health crisis. Metal and oil prices have skyrocketed recently, and producers find it increasingly difficult to meet demand. In fact, the China – United States trade war and Covid-19 pandemic forced many producers to reduce capacity while there has been little investment in new coal, gas, and oil supply projects.

In addition, the current commodity supercycle is marked by a growth in demand for agricultural products and specialty metals such as silver and gold. Agricultural commodities, in particular, are expected to increase in value due to demand for biofuels and demand from China. As air quality, water, and land are at a premium, demand for agricultural products will remain high in China for the next 5 – 10 years.

The conflict in Ukraine is also pushing up agricultural commodities prices, with over 17 percent increase in the price of corn, barley, oats, and other grains. Vegetable oils have seen the biggest price hikes (23.2 percent) as Ukraine is the biggest sunflower oil exporter while Russia is the world’s second biggest. Skyrocketing prices for grains, corn, vegetable oils, and wheat are already threatening food shortages around the globe. Shortages are mainly caused due to disruptions in export flows, with large quantities of produce still sitting in Ukraine because of the blockage of major ports. There is also a risk that some crops would be damaged or destroyed, including spring crops such as soybeans, barley, and corn.

Demand for commodities is expected to increase further as economies around the world are gradually reopening after a significant rise in vaccination rates.

How Is the New Supercycle Different?

When a new supercycle is to occur, we are likely to see some differences. One is the green fiscal stimulus that couples up environmental objectives with crisis spending and efforts to restart the global economy. This transition to a system that is more efficient and cleaner is expected to give rise to new emerging sectors and new jobs and opportunities. The American Jobs Plan, for example, includes a proposed $174 billion investment to accelerate the domestic electric vehicle industry, coupled with commitments to green infrastructure and clean energy. The European Union also agreed a massive green stimulus, with funds to be invested in alternative fuel projects that support climate action. China has announced plans to reduce emissions and achieve carbon neutrality by 2060. In Canada, Covid-19-related spending was the main focus of the previous two budgets but in 2022, the federal government announced a comprehensive package of measures aimed at reducing greenhouse gas emissions. Under the 2030 Emissions Reduction Plan, Canada is taking action to promote clean industrial growth, create sustainable jobs, and achieve zero-net emissions by 2050.

This focus on clean energy means that if a new commodity supercycle is to occur, it will be driven by an increased demand for copper. Copper prices already increased by 17 percent in 2021 amidst sustainable and green initiatives. Copper has a wide range of applications such as high conductivity wires, electrical cables and wiring, and power transmission lines. It is used in green and traditional infrastructure and is a major component in electric vehicles, including charging stations, wiring, inverters, batteries, and electric motors. At the same time, shortages are expected to occur due to pandemic-related disruptions of mining operations in Peru and Chile and an increased demand in China. While demand from China is expected to gradually moderate, it will not do so in many parts of the world.

It is clear that the various green stimulus packages and climate change plans will not drive demand for fossil fuels down, at least not in the short run. After all, if we want to build green infrastructure, we will need traditional fuels. Long-term implications, however, are far from clear.

Inflation rates are record high around the world, and Canada is no exception, with an 18-year high of 4.7 percent in November. Prices rose across sectors, ranging from bakery, dairy, and meat to furniture, household products, energy, and transportation. A combination of factors is driving inflation, the main being money printing, high oil prices, product shortages, supply chain disruptions, and pent-up consumer demand.

Reasons for Record High Inflation

Whether high inflation rates are driven by global supply chain issues or money printing is a hotly debated issue at the moment. In the view of some academics and finance experts at the Bank of Canada, it is supply chain disruptions that cause inflationary pressures and drive food and energy prices up. According to a second group of academics, monetary printing creates an overabundance of demand while supply would not always catch up. The result is inflation whereby prices rise and purchasing power declines.

If we take the monetarists’ argument, inflation is not a temporary phenomenon and requires a tight fiscal policy and interest rate hikes. Such policies would involve tax increases, spending cuts, unemployment, and recession. Recession is generally a period of economic decline marked by substantially lower levels of industrial and economic activity. Businesses see less demand and are forced to lay off workers to cut costs, generating unemployment and insecurity.

As prices rise, inflation also eats away at our money and savings. Inflationary pressures not only result in an overall decline of purchasing power but affect the performance of companies and interest rates on savings accounts. When inflation is high, central banks would typically raise interest rates to discourage consumers from borrowing and buying and keep the cost of goods and services stable. The Bank of Canada recently signaled that interest rate hikes cannot be ruled out as a way to keep inflation under control. The current situation, however, is high inflation and low interest rates on savings whereby the value of your money declines. Fortunately, there are plenty of things to do to protect your savings, like investing in real estate, precious metals, commodities, crypto, and defensive stocks.

Investing in Real Estate

As the value of real estate rises with inflation, rental income can be a potential hedge, especially when it comes to short-term leases such as multi-family properties. Investors who are able to keep their mortgage terms the same and adjust their rent up benefit from inflation. Investing in real estate also provides recurring income that either exceeds or keeps pace with inflation.

Precious Metals

Precious metals such as platinum, silver, and gold are known to be a hedge against inflation as well as a portfolio diversifier. Each precious metal, whether palladium or gold, has its own unique specifics, benefits, and risks. Gold, for example, is less affected by demand and supply, making it easy to sell and buy. An added advantage is the fact that there are different investment options to choose from, including numismatic coins, bars, and proof and bullion gold coins. The downside is that it doesn’t produce passive income the way real estate does.

Commodities

When inflation is high, commodity prices also rise and offer a good return potential. Unlike financial assets such as bonds and stocks, commodities are one of the few investment classes that actually benefit from inflationary pressures. The rationale is that rising demand for services and products results in price increases and hence, the value of the commodities that go into producing goods and services also increases.

Bonds and stocks, on the other hand, tend to perform better when the inflation rate is either slowing or stable. When inflation picks up, it reduces the interest rate that bonds pay while high-dividend and income-oriented stock prices fall. This is why returns from commodity indexes like the S&P Goldman Sachs Commodity Index, Credit Suisse Commodities Benchmark, and Bloomberg Commodity Index are independent of bond and stock returns.

Defensive Stocks

Defensive stocks offer stable earnings and dividends regardless of market conditions and typically outperform other investments in periods of economic decline such as recession or stock market crash. The reason is that they belong to sectors of the economy where there are only minor changes in demand. Such sectors are, for example, healthcare, utilities, and food and beverages. The consumer defensive sector includes businesses engaged in the production of packaging, personal and household products, food and beverages, and tobacco. The sector also includes companies offering services such as training and education. Organizations providing healthcare services fall in this category, including medical supplies and equipment, long-term care facilities, hospitals, home health care, research services, and pharmaceuticals. Examples are also life science development and biotech, vaccine developers, and medical device manufacturers. A third sector is utilities, comprising independent power producers and water, gas, and electric utilities and a fourth – communication services such as media and advertising, 5G network, and telephone and broadband.

Crypto Currencies

Investing in crypto currencies can be a viable alternative to stocks and bonds, with a return of over 6 percent. Proponents point to the fact that bitcoin is not tied to a particular economy, fiscal policy or currency and cannot be devalued by a central bank or government printing money. Not only is bitcoin a digital currency but it has a limited supply and is secure, interchangeable, and durable. Finance experts, however, warn that crypto is a highly volatile asset and one tied to speculative trading. Also, cryptocurrencies have been around for a relatively short period to establish whether they can really act as a hedge against inflation.

Gold, on the other hand, has held its value for centuries. Academics at Duke University also note that bitcoin is vulnerable to crashes and manias over relatively short periods, which makes it a risky asset. Its value is tied to two factors – speculative trading and supply. All in all, bitcoin may have a limited value in developed postindustrial countries with stable fiat currencies. Crypto currencies may have a more practical use in countries prone to political instability and turmoil and hyperinflation.

Summing Up

Inflation is currently higher than normal in Canada, primary drivers being money printing, pent-up demand, and supply chain bottlenecks. Droughts affecting agricultural produce across the country are only making things worse.

Global supply chain disruptions are likely to continue in 2022, mainly due to China’s Covid-19 zero policy, resulting in delayed ships and overwhelmed ports. Inflation rates of 4 – 5 percent could also be with us until 2024. While these changes are temporary, a shift in Canada’s monetary policy may not have the desired effect. Hiking interest rates would result in economic slowdown at a time when governments around the world are withdrawing emergency support and fiscal stimulus.

What Canadians can do to protect their savings is invest in precious metals, real estate, defensive stocks, or commodities, all of which acting as a hedge against inflation. Other assets that offer protection against inflation are leveraged loans, real estate investment trusts, and mortgage-backed securities and corporate bonds.