Have we fallen off the cycle or is the bike broken?
Since 1998, commodities have been in a bull market—the so-called supercycle, where surging demand for raw materials eclipses supply, juicing prices to abnormal highs.
Lately, though, it has been all downhill for commodities. On Morgan Stanley’s MS -0.72% recent earnings call, finance chief Ruth Porat characterized this weakness as cyclical rather than structural. But a more fundamental shift appears under way.
Two things underpinned the upswing in industrial commodities. First, low prices discouraged investment in new oil fields and mines through most of the 1980s and 1990s. Second, demand in emerging markets, especially China, jumped. Neither factor will hold this decade in the way they did during the last.
High prices have encouraged investment in new supply. The most obvious example is the rebound in U.S. oil-and-gas production. Globally, spending on oil-and-gas resources is forecast by consultancy IHS Herold at almost $700 billion this year, more than four times the level of 10 years ago.
Something similar is happening with industrial metals and minerals. Caterpillar CAT -0.37% just cut its guidance, citing weak demand for mining equipment. Excess capacity has weighed on aluminum for years and has also started hitting iron ore.
Now, copper is starting to feel the effects. Barclays BARC.LN -1.26% estimates global copper supply outpaced consumption last year and will continue to do so at least through 2014, reversing the deficits of 2010 and 2011. Inventories of copper are building, and it is noteworthy that J.P. Morgan Chase and others now want to launch copper-backed exchange-traded funds—one way of wringing profits from piles of idle metal.
Just as supply accelerates, growth in demand has softened. Sluggish growth and enhanced fuel efficiency, especially in the U.S., mean the International Energy Agency expects oil demand in advanced economies in 2017 to be lower than in 1997.
For oil bulls, China is the great offset to this. In the decade ended in 2007, it accounted for 29% of oil-demand growth. Two other centers of growth in oil demand are the former Soviet Union and the Middle East. Looking to 2017, the IEA expects their combined demand to rise faster than China’s. Yet these two regions’ economies are heavily tied to energy exports, so estimates for their oil consumption rise and fall with China’s fortunes.
Oil consumption in China over this decade is unlikely to repeat the surge of the last one, when it almost doubled. In that earlier period, China burned between one and 1.5 barrels of oil per $1,000 of real gross domestic product, according to Raymond James. By 2012, that had slipped below one barrel.
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