Saturday, April 6, 2013

Commodities: Super-cycle? What Super-cycle?

The stock markets are in rally mode. Both the S&P 500 and Dow Jones reached all time highs and gained around 10% this year to date. But commodities didn`t follow. The Standard & Poor’s GSCI index of 24 raw materials, which captures oil, copper, corn, coca, sugar and other commodities, has been stagnating in the first quarter of the year, reports Bloomberg (bloomberg). Today the prices for oil, copper, corn, cocoa and other commodities are far below the peaks they had reached in 2008 (oil $147), 2011 (sugar, coffee) and 2012 (corn).

This is a huge disappointment for those who believed Goldman Sachs and other banks. Their commodity analysts have been banging the "buy commodities" drum for years. The banks were supported by pretended gurus like the famous investor Jim Rogers. The media star was quoted in August 2011 with "he won’t be buying stocks anytime soon. And he sees a “super-cycle” in commodities. He believes this commodities super-cycle has another 20-25 years to go" (barrons).

The devotees of the "super-cycle theory", which has been heavily advertised by banks, brokers and commodity gurus, claimed that commodities are getting more and more scarce and hence more expensive. They further alleged that a rising demand from China and other emerging countries would exhaust the supplies of oil, corn, metals and other materials. Part of this commodity cult was the "peak oil theory" which claimed that the world oil production had reached its peak and will  shrink from now on which will cause drastically climbing fuel prices.

All these claims remind of the reverend Thomas Robert Malthus, who lived from 1766 to 1834 (wikipedia). The British philosophy (Malthusianism) and his followers predicted that the world will soon run out of food because global population would grow faster than the supply of wheat and other agricultural products. Even though this nonsense has been confuted very often, Malthus`theories are still popular (Club of Rome)

A lot of hedge funds and other speculators subscribed into the "super-cycle" theory and have been pumping billions of Dollars into oil, sugar, cocoa and other commodity markets. Others jumped onto the "malthusian" bandwagon and bought commodities (or financial products based on them) just because their price was climbing in the hope that the price rise will continue. The herding behavior of the commodity speculation created high prices for material in the recent years - a self-fulfilling prophecy, at least for a while.

But "super-cycle" and "peak oil" claims are based on ignorance and economic illiteracy. Their adherents neglected human nature and factors like ingenuity, frugality and profit orientation. In fact, people have been responding to scarcity and rising prices all the time. Generally higher prices have been animating producers to produce more because they get higher profits. On the other side, consumers have been switching to cheaper alternatives and have been developing methods to deal with rare resources for thousands of years.

The high oil prices in  recent years animated, for instance, an oil boom in the U.S. With the help of technological progress, which allowed deep sea drilling and hydraulic fracturing, or fracking, of hidden oil reserves, the American production of oil & natural gas has been steadily climbing. Now it seems America is on the verge of energy self-sufficiency within a decade. Other countries may follow.

Farmers also responding to high & rising prices for their products. They did what they always do when their products get more expensive:  They planted more sugar, cocoa and other agricultural products. In doing so they too benefited from technological progress: Advanced seed and fertilizer products, along with agricultural equipment liker tractors, loaders, harvesters and the like are enhancing the productivity of farming. As a result we are now seeing the rise of record harvests for sugar, cocoa and other products. Last week the U.S. Department of Agriculture said they expect that farmers in the U.S., the world’s biggest grower and exporter, will plant the most since 1936.

On the other hand, rising prices for commodities lead to a demand destruction. For instance, because people are driving less and less in cars, which - on average - burn less gasoline, U.S. oil demand is shrinking.  But not only are cars becoming more and more energy efficient: Modern refrigerators, washing machines, air conditioners and many other household appliances use less electricity than older models.

Consumers are also responding to rising agricultural prices. Expensive sugar animates more use of other sweeteners, climbing cotton prices suggest switching to synthetic fibers, costly wheat gets substituted with potatoes and so on (a substitution effect). All those economic effects keep the commodity prices in abeyance and prevent running out of raw materials soon.

There has never been a super-cycle and it is highly unlikely to come. Instead it looks as if we entered a long period of weak commodity prices comparable to the years 1982 till 2000 which will lead to prosperity and a marathon rally on the stock market.

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