Commodity Super-Cycle and Decline

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Unrest and slowdowns mark the end of a placid decade, writes Ruchir Sharma

Protests erupt in the formerly happy middle classes of Turkey and Brazil. A credit crisis threatens the Chinese economic juggernaut. Money flees the stocks, bonds and currencies of emerging nations. Is this the end of the emerging world miracle? Not exactly. This marks a return to the normal postwar cycle of recession and recovery, political unrest and calm, after a misleadingly placid decade.

This age is chaotic only in comparison to the brief “Goldilocks” era that began in 2003. Before that year, the emerging world’s share of global economic output had been stagnant for half a century and in decline for a decade, undermined by debt crises that struck from Thailand to Russia. By the late 1990s, these emerging nations were turning to a new generation of leaders, headed by the likes of Luiz Inácio Lula da Silva in Brazil and other giants, including Vladimir Putin in Russia and Recep Tayyip Erdogan in Turkey.

These leaders laid a stable economic foundation for the boom that began in 2003 after the US Federal Reserve and other central banks cut interest rates sharply to engineer a recovery from the technology bust. Much of the resulting easy money flowed into the emerging world, doubling the average annual gross domestic product growth rate to about 7.5 per cent from 3.6 per cent in the previous two decades.

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Sluggish global growth and a recent economic slowdown in resource-hungry China have hammered commodities markets this year, sending the price of everything from iron ore to copper tumbling. With those sharp reversals—as well as the Fed’s comments about tapering the size of the United States’ monetary stimulus—fresh in their minds, the 300 clients who convened last week at Credit Suisse’s New York headquarters for the bank’s third annual Commodities Day had plenty to talk about.

With few exceptions, the prices of commodities such as oil products, precious metals and industrial metals have been steadily rising over the past decade in what analysts have termed a “commodities supercycle.” That era is over, Credit Suisse experts say, and they expect prices to remain under pressure at least through the end of the year.

What’s more, the prices of individual commodities will no longer rise and fall together as they have for the last five years, Credit Suisse’s commodities team explained in a June 25 research note (“Commodities Forecast Update: The Return of Fundamentals”). As a result, investors and traders are going to have to focus on the specific supply and demand dynamics for individual commodities.

Copper and iron ore prices, for example, are expected to decline because supplies of both metals are becoming more plentiful at the same time that demand is declining.

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NEW YORK – (Reuters) – Investors who have plowed some $400 billion into raw materials markets over the past 10 years are accelerating efforts to change their strategies, if not their allocations, on the growing belief the commodities “supercycle” has come to an end.

While pension funds and other institutional investors have been quick to bail on gold as bullion fell deeper into bear market territory in the second quarter, they have yet to abandon other markets like oil and metals en masse, asset allocation experts and analysts say.

Instead, more and more funds are changing tack, abandoning the passive, buy-and-hold strategies that held sway in the previous decade to embrace a more active approach to picking winners and losers within the commodities sphere.

While the shift toward ‘active’ investing has been growing for several years, the pressure to adapt is mounting. The 19-commodity Thomson Reuters-Jefferies CRB index .TRJCRB fell 7 percent in the second quarter and 25 percent from a second-quarter 2011 peak, entering bear market territory.

Among individual commodities, the second quarter was gold’s worst on record due to fear the U.S. Federal Reserve will curb stimulus money crucial to bullion prices.

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Over the past month, global financial markets have become terrified by the prospect of a Chinese economic slowdown. Last week, the interbank lending rate in China jumped precipitously, suggesting that Chinese banks, which for years have been piling up debt lending to state-owned enterprises and building infrastructure, may now be facing a severe credit crunch. China’s money markets slowed to a near halt, China’s stock markets suffered whiplash, and many Western fund managers began lightening their China exposure.

To some, Chinese banks’ debt loads signal the arrival of an event doomsayers have been predicting for decades—not just a slowdown but a meltdown of China’s economy. That, of course, would be catastrophic for the international economy, since nearly every other country in Asia is dependent on trade with China—as are most Western multinationals.

But although international markets, the original kind of crowdsourcing, often deliver the right verdict, there’s good reason to bet they’ll be proven wrong this time. The Chinese economy, the second-largest on earth, is not going to melt down soon; in fact, it might still grow more strongly this year than most others in the world.

Almost since it began reforming in the 1970s, China’s economy has attracted skeptics. By only partially privatizing massive state companies over the past 20 years, the government has been criticized for creating enormous inefficiencies, building up more than 100 “national champion” companies in such industries as energy, telecommunications infrastructure, and automaking and using cheap credit from state banks to help these indigenous companies grow.

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Clyde Russell is a Reuters market analyst. The views expressed are his own.

HONG KONG, June 27 (Reuters) – It was hard to find anybody who didn’t profess to be bullish about the outlook for China’s commodity demand at LME Week Asia, but what is changing is exactly what market insiders mean when they express optimism.

The first major shift in thinking among participants at the metal industry’s gathering this week in Hong Kong is that it appears that they are bullish about volumes, but not necessarily about prices.

The boom in China’s commodity imports in the past decade was accompanied by a surge in prices, but it appears the market is finally coming to terms with the fact that this nexus has broken down.

Take iron ore and steel for instance. It’s not an unreasonable forecast to believe that China’s demand for iron ore imports will rise from 745 million tonnes in 2012 to a figure closer to 1 billion tonnes over the next 10 years.

Demand for the steel-making ingredient will be driven by China’s ongoing urbanisation and the infrastructure building associated with this process.

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The commodities “supercycle” is dead. If anyone was still in doubt about whether the era of ever-rising prices driven by rapid Chinese growth was over, events of the past week have surely dispelled it.

The dollar rally after the Federal Reserve’s hints about tapering its “quantitative easing” programme, together with fears about a liquidity crunch in China, have sent a ripple of fear through the commodities industry.

So what should investors do about it? The answer may be less obvious than it seems. Most commodity prices have already fallen dramatically. Since their respective peaks in 2011, copper prices are down 35 per cent, iron ore prices have fallen 40 per cent, and gold has tumbled 36 per cent.

“People have generally been positioned for the slowdown in materials demand,” says Kamal Naqvi, head of commodity sales at Credit Suisse. “But we’re getting towards the end of that particular trade. For metals to be a conviction short from here, clients are waiting on confirmation that demand is worse and/or that supply is better than people have been factoring in.”
The shares of commodity producers have been under even more severe pressure. Anglo American shares are down 64 per cent from their 2011 peak; Vale is 45 per cent lower; and Kazakhmys has lost 85 per cent.

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