Punching above its weight | The Star


THE resurrection of the global economy following a major crisis would always involve a cycle of commodity boom as countries embark on massive economy rebuilding efforts that usually throws the supply and demand equation off balance.

The Covid-19 pandemic, which is still wreaking havoc, threw economies into a disarray last year as governments tried to weigh between lives and livelihoods.

The resultant lockdowns hit the pause button on business activities and global productions and commodities plunged alongside them.

But it did not take long for prices of commodities to start taking off again, mainly due to the effects of pent-up demand in a yet to be resolved disruption in supply chains.

Year-to-date (y-t-d), the Bloomberg Commodities Index is up 22% to 95.16 points, a level not seen for at least six years.

Brent crude oil is up 40% to US$72.53 (RM297) per barrel, copper is up 27% to US$9, 890 (RM40, 549) per tonne after hovering above US$10, 000 (RM42, 000) last month while crude palm oil has soared more than 60% to about RM4, 000 per tonne.

And if one were to refer to the commodities-to-equities ratio or the S&P GSCI to the S&P Index, it may seem that commodities are still “dirt cheap”.

The GSCI was formerly known as the Goldman Sachs Commodity Index, before it was purchased by Standard & Poor’s in 2007.

The ratio bottomed out at 0.44 in April last year, the lowest point ever recorded since 1970.

This is lower than the points when the New York Stock Exchange’s (NYSE’s) Nifty Fifty crashed in the 1970s and during the tech bubble from the late 1990s to 2000.

Socio-Economic Research Centre (SERC) executive director Lee Heng Guie (file pic) tells StarBizWeek it is the combination of demand, supply, fiscal and monetary policies as well as structural and environmental changes that are likely to support strong commodity prices for longer.Socio-Economic Research Centre (SERC) executive director Lee Heng Guie (file pic) tells StarBizWeek it is the combination of demand, supply, fiscal and monetary policies as well as structural and environmental changes that are likely to support strong commodity prices for longer.

The previous trough was in 1998 at a ratio of 1.6, peaking out at more than eight ten years later.

This might mean two things, that equities are either overvalued in a Covid-19 recovery optimism or that commodities, despite their rallies, are still severely undervalued.

A handful of analysts were quick to conclude that the wave of a new supercycle is imminent but nobody really paid attention, until giant investment banks started making their calls, though there is another school of thought questioning the sustainability of the supercycle this round.

The definition of a supercycle, according to Capital Economics’ group chief economist Neil Shearing, is a period in which prices rise continuously over several years before going through an equally prolonged decline.

He wrote that it happens due to large and sudden shifts in demand for commodities but when supply is often slow to respond.

This resonates with the current Covid-induced economic uncertainty where operations are capped at a certain level, such as 60% in Malaysia, due to movement restrictions to curb the spread.

At a time when economies are starting to open up as inoculations pick up pace, businesses, manufacturers and suppliers alike are still yearning for full scale operations to ramp up efficiency to deal with the piling demands but governments everywhere are not willing to take that risk just yet, not until herd immunity can be achieved in their respective countries. Brace for supercycle 5.0

There have only been four supercycles over the past century. The first came during the 1890s to the 1910s during the rapid industrialisation and urbanisation of the United States.

The second round landed during the Great Depression in the 1930s, which stretched all the way to the 1950s due to massive rebuilding in Europe and Japan after World War II.

Juwai IQI global chief economist Shan Saeed (file pic) says the global economy is on the verge of a commodities bullish cycle for the next two years as investors prepare to take positions in this asset class.Juwai IQI global chief economist Shan Saeed (file pic) says the global economy is on the verge of a commodities bullish cycle for the next two years as investors prepare to take positions in this asset class.

The third was due to oil price shocks in the 1970s and rapid growth in Japan while the fourth cycle took place in the 1990s during China’s rise to becoming the economic superpower that it is now.

This supercycle ended roughly during the Global Financial Crisis in 2008.

Goldman Sachs, in its commodities outlook dated Nov 18 last year, says that looking at the 2020s, they believe similar structural forces to those which drove commodities in the 2000s could be at play.

Among all these triggers for the supercycles, there seems to be a similar component – building and developing – something that is bound to kick in full force in a post-Covid world as governments, who have been sitting on piles of cash, are ready to spend.

The Joe Biden administration for example, is planning to spend US$1.7 trillion (RM6.97 trillion) over the next decade and a proposal of US$6 trillion (RM24.6 trillion) for the fiscal year 2022.

Socio-Economic Research Centre (SERC) executive director Lee Heng Guie tells StarBizWeek it is the combination of demand, supply, fiscal and monetary policies as well as structural and environmental changes that are likely to support strong commodity prices for longer.

He explains that prices will remain supported as the global economy recovers over the next 18 months, especially with pent-up demands from China and the United States, as well as other advanced economies.

“The ongoing fiscal stimulus and highly accommodative monetary policy will support the demand for resources such as metals and copper for public infrastructure projects.

“Easy liquidity conditions and low-cost borrowings sustain consumers’ spending buoyancy.

“Demand for agricultural commodities, such as corn, soya beans and pork are also likely to rise, driven largely by China, ” he says, adding that countries have also embarked on long-term plans to build food strategic reserves, wheat and staple food, to lower their import dependency in order to strengthen the food supply risk management due to the supply chain disruptions during the Covid-19 crisis.

Juwai IQI global chief economist Shan Saeed says the global economy is on the verge of a commodities bullish cycle for the next two years as investors prepare to take positions in this asset class.

“All the major commodities are showing strength from corn to soybean to cobalt, nickel, iron ore, oil, copper and orange juice. Commodities have gone up from 20% to 125% roughly in the last 17 months.

“The question that arises is, is this sustainable? Once the global economy comes back post Covid-19 recovery, the commodities market will reach to the point where the demand and supply equation becomes fair as per the market forces, ” he says.

Shan notes that the current boom is a classic bull-market cycle for many commodities as the world, along with China, emerges from the pandemic and reacts to stimulus measures..

“This heralds good news for China, which is the world’s top exporter of some commodities like rare earth steel materials and steel-based products.

“Construction sites are some of the few areas of the economy that have remained open and in places like China, the government has been trying to stimulate that part of the economy.

“The fiscal stimulus plans outlined by countries – including the UK and the Biden administration in the US – are likely to increase demand for metals and energy to build green infrastructure, ” says Shan.

CGS-CIMB Research in a report earlier this month, mentions that it looked as if the last cycle was close to running its course by the start of last year.

It says the sharp fall in mining capital expenditure from 2014 to 2016, which coincided with a massive price slump, had stabilised and started picking up by 2019, suggesting the beginning of a new cycle, before the Covid-19 pandemic hit.

“We now appear to be at the beginning of a new cycle, with likely added vigor caused by fiscal stimulus in the world’s two largest economies – the US and China.

“We believe that the infrastructure spending in these economies will likely drive competition for commodities, inventory building, and yet higher prices.

“We see this already starting to flow through into both producer and consumer prices.

“Higher commodity prices – abetted by supply chain disruptions – recently shocked the economy through higher producer prices coming out of China, ” it says, adding that as China focuses on growing domestic consumption, it is unlikely to absorb higher costs through repressed wages or significantly lower margins.

It expects Chinese producers to continue passing on the higher costs.

Clean and green energies

It can be noted that the prior supercycles were mostly based on single factors such as rebuilding or rapid growth.

Where the Covid-19 supercycle stands to differ is its multi pronged pressure and demand.

Besides the massive infrastructure plans, there is a technological and regulatory shift towards cleaner and greener energy and electric vehicles (EVs), technological changes of consumption habits with the trend of working and learning from home and the fourth industrial revolution (IR4.0)

These developments require more commodities than the industries have ever seen.

The International Energy Agency (IEA) says in a special report last month that a typical electric car requires six times the mineral inputs of a conventional car and an onshore wind plant requires nine times more mineral resources than a gas-fired plant.

It adds that the world is currently on track for a doubling of overall mineral requirements for clean energy technologies by 2040.

Lee says the massive capital investment to facilitate the energy transition, switching to clean energy sources and electric vehicles as well as more renewable energy sources will set off demand for commodities such as metals and also copper for use in EV batteries and associated charging infrastructure.

An analyst says the Biden Green Energy agenda is clearly helping the silver supercycle with palm oil being a strong beneficiary.

“Palm has no story at all this year. The supply remains good but prices are through the roof.

“The entire veg oil price structure is hanging on by the slim thread of green energy pricing in the US.

“Can that single thread continue to keep the bull market alive? And for how long? We have upcoming weather factors in North America in July and August that will help shed some light for us, ” he says.

Shan concurs that the green energy market is in vogue and for the next 10 to 15 years, investments in clean energy infrastructure, clean transportation and everything else that is required to make the green transition possible would be very attractive.

He says higher fossil fuel prices could increase the appetite for low-cost renewable energy, which will be even cheaper by comparison as those prices rise.

“Low-carbon energy will be even more economically attractive to major energy users especially in Europe thanks to record high prices for carbon permits on the EU’s emissions trading scheme, ” says Shan.

Inflationary concerns

In line with the increase in prices of raw materials, consumer inflation is also expected to rise as producers and manufacturers would be forced to pass the costs through to consumers if they are unable to swallow the hike.

Lee says the rising commodity prices have been a boon to producers and exporters of oil, palm oil, minerals as well as copper and metals.

Metals have benefited from a rush to replenish manufacturing supply chains and the prospect of years of green spending.

“For net importers that are heavily dependent on these commodities and minerals as raw materials, they have incurred high inputs cost and cost of production.

“These include the consumer sector, food processing, transportation, automobile, construction and manufacturing sectors, ” he says.

Lee adds that an increase in prices would then stimulate investments in the commodities sector to meet high demand.

If the supply is insufficient to meet up the expected surge in demand, this will push prices even higher and stimulate investment.

Meanwhile, Shan says commodity-based economies such as Malaysia are likely to benefit from the bullish driven cycle while importers such as Japan and India would be suffering.

“The market is also asking if there is food inflation hitting the global economy next year. Certainly, due to four reasons.

“This is due to changing weather patterns, the demand and supply equation, the underinvestment in the agricultural sector in the last 30 to 35 years and the hiccup in the global supply chain.“Consumers will have to pay higher prices globally and food inflation remains inevitable as economies open up next year and higher demand is building at the macro level at the moment, ” he says.

Meanwhile, Lee expects the commodity prices upturn, which started in the second half of last year to continue, albeit with some volatility, for two to three years, depending on the interplay of economic growth, the strength of demand, supply bottlenecks, speculation, weather factors and the environment.

For example, he says the shelf-life of some commodities like copper and aluminium would last for a longer period due to the transition to green theme investments, moving to a low carbon economy.

Shan foresees that the price inflation in commodities will continue for the next two to three years before hitting normal ranges.

He says the depreciating US dollar is among the factors for the continuous surge, after losing 16% of its value over the last 15 months.

“The Fed is not going to hike interest rates before 2023. In my view, the greenback is heading for tail risk and this is going to create a crisis in the form of a stagflation – which is a higher inflation and unemployment with lower growth.

An analyst stresses that inflation will definitely be a problem in the months to come.

Like all previous supercycles, he is of the opinion that this one will also end when euphoria gets the better of caution and when everyone thinks “This time it is different”, the four most costly words in the English language, according to the late Sir John Templeton.

Perhaps it is the former fund manager’s other quote that investors should pay more attention to, that is: “Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria”.

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