FALLING OFF THE COMMODITY SUPERCYCLE / THE WALL STREET JOURNAL ( A MUST READ )

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Updated March 12, 2012, 6:52 p.m. ET
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Falling Off the Commodity Supercycle
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By LIAM DENNING

Discussion of the supposed commodity "supercycle" tends to focus more on the "super" and less on the "cycle." But all true cycles eventually head down. This one could turn in 2014.



The current commodity supercycle can be dated to 1999. The major commodity indexes all hit their lows for the last 20 years early that year or in late 1998. Since then, the S&P GSCI index has risen fivefold, albeit with some wild swings.

China used 71 million metric tons of steel for every percentage point of GDP growth last year, according to UBS. Above, laborers install steel bars on the foundation of a residential construction site.

Two things explain this. The first is the recurrent Malthusian fear that the world is exhausting its stock of raw materials—think "peak oil." Surging Chinese demand has been the major cause of such fear.
Between 2000 and 2010, China accounted for 40% of the increase in global oil consumption and 123% for copper.


Cheap money has added fuel to this fire. Very low or negative real interest rates in most major economies have made it attractive to own commodities in anticipation of realizing higher prices later on. That is as true of a hedge fund borrowing at low rates to keep copper in a warehouse as it is for Saudi Arabia keeping some oil in the ground rather than pumping it now, only to invest the proceeds in low-yielding U.S. Treasurys.


Both of these pillars are now under threat. China's latest trade-deficit numbers, released this weekend, show a marked slowdown in growth in processing trade imports—the raw materials for China's own exports. That suggests weakness in developed economies, particularly in Europe, is causing Chinese exporters to scale back.


So is Beijing, which just cut its annual gross-domestic-product growth target. Infrastructure investment in the latest five-year plan is down 25% in real terms from the preceding one, according to UBS. While investment in public housing continues, it is unlikely to offset the sharp fall in private housing starts as China's property bubble bursts. This suggests breakneck infrastructure investment in China is slowing.
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Despite the commodity bulls' mantra of China needing to catch up to Western levels of consumption, its raw-materials consumption is already staggeringly high. Last year, China used 71 million metric tons of steel for every percentage point of GDP growth, according to UBS. That is the equivalent of almost 1,400 Empire State Buildings—per point. Meanwhile, Chinese per capita consumption of copper in 2010 was already above the level for the North American Free Trade Agreement, according to consultancy Bloomsbury Minerals Economics, despite China's GDP per head being far lower.



The transition in China's economy is in its infancy, but the shift should become clear within a couple of years.


Just as this undermines expectations of continuing commodity-price increases, so should a shift in global monetary policy. The Federal Reserve expects that abnormally low interest rates should start rising in late 2014. But fed funds futures increasingly indicate rates will rise sooner than that, perhaps as early as the start of that year.


Chris Watling, who runs research firm Longview Economics, identifies three periods in the past 80 years where episodes of ultra-loose U.S. monetary policy have coincided with upswings in the commodity-price cycle. These encompass the 1930s through the 1940s, the late 1960s through the 1970s, and the current period since 1999.


Based on the historical record, Mr. Watling surmises commodity supercycles—which tend to coincide with equity bear markets—last between 15 and 25 years. By that reckoning, the commodity cycle could start turning in 2014, although his analysis clearly implies a wide range of timing.


Commodity futures, by their nature, look forward to the supply and demand dynamics (and financing costs) of tomorrow. Even before the full implications of changing policies in Beijing and Washington become clear, commodity prices will likely have shifted down in anticipation.

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