The Next Leg of the Commodity Supercycle?

For related podcast discussion, see Commodity Supercycle: Derailed, Delayed, or Unfolding as Expected?

In the aftermath of the 2020 COVID-19 crash, supply disruptions, and subsequent massive stimulus injections, commodities experienced a significant surge. This led many analysts, including myself, to predict the beginning of a new commodity supercycle - a prolonged period of rising commodity prices that could unfold over this decade. Now, four years later, it's time to reassess whether this thesis remains valid or if it has been derailed, delayed, or unfolding as anticipated.

What Is a Commodity Supercycle?

A commodity supercycle typically involves an extended period of at least five years or more of consistent price increases across a broad range of commodities. These cycles often emerge after a long lag between commodity prices and changes in supply. As economic growth drives up demand for commodities, supply eventually falls short, putting upward pressure on prices. This continues until prices become attractive enough to incentivize producers to increase supply.

The last major commodity supercycle occurred in the 2000s, driven largely by China's rapid industrialization. During that period, oil prices surged from $10 to $150 per barrel, gold rose from $250 to nearly $1,900 per ounce, and silver climbed from $3-4 to $50 per ounce.

Key Drivers of the Current Commodity Supercycle

While the previous supercycle was primarily fueled by China's economic boom, the current cycle has several distinct drivers:

1. The Energy Transition: The global push towards renewable energy and reduced carbon emissions is creating massive demand for certain commodities. However, it is also putting a simultaneous constraint on supplies due to stringent environmental policies.
2. Global Population Growth: More people on the planet leads to higher overall consumption of commodities.
3. Emerging Market Consumption: As middle classes grow in emerging economies, so does their consumption of goods and commodities.
4. Technological Advancements: The rise of electric vehicles, renewable energy infrastructure, and digital technologies is driving demand for specific metals and minerals.

Oil: Peak Production and Supply Concerns

The shale revolution in the United States has been a game-changer for global oil markets over the past decade. The U.S. has become the world's largest oil producer, with shale accounting for about 90% of the increase in global oil supply. However, there are growing concerns about the sustainability of shale production:

• Many major shale plays have already peaked (Eagle Ford in 2015, Bakken in 2019).
• The Permian Basin, the last major shale play, may be nearing its peak.
• Decline rates in shale wells are accelerating.
• Companies are increasingly drilling lower-quality "tier 2" and "tier 3" wells.

As U.S. shale production potentially peaks and declines in the coming years, it could lead to a significant tightening of global oil supplies. This may result in higher oil prices, with some analysts suggesting the possibility of $200 per barrel oil in the future.

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Copper: The Cornerstone of the Green Energy Transition

Copper is set to play a crucial role in the global push for net-zero emissions by 2050. It is essential for renewable energy infrastructure, electric vehicles, and the expansion of electrical grids. Some key points regarding copper demand and supply:

• Global electrification could increase annual copper demand by 36.6 million tons by 2031 (McKinsey).
• Copper consumption for green energy applications is projected to rise from 4% in 2020 to 17-20% by 2030.
• Overall copper demand could double to 50 million tons by 2035.
• Current global copper supply is growing at only 2.7% annually and is projected to reach just 31 million tons by 2030 - far short of anticipated demand.
• There has been a lack of major copper discoveries over the past 15 years.
• It takes 15-20 years to bring a new copper mine into production.

These factors point to a looming supply deficit in copper, which could drive prices significantly higher in the coming years.

Silver: Industrial Demand and Supply Deficits

Silver is unique among commodities as it serves triple duty as an industrial metal, a green energy material, and a monetary metal. Key factors influencing the silver market include:

• Supply deficits have occurred annually since 2021 and are projected to continue.
• Industrial use accounts for 55-60% of silver demand, with solar panel production being a major driver.
• Solar has tripled its silver demand in recent years and may account for 32% of silver supply by 2024 (Bloomberg).
• Silver supply has been essentially flat for the last decade and fell 1% in 2023.
• The deficit is projected to be 17% in 2024, with nearly half a billion ounces of silver inventory drawn down.
• China, as the world's largest producer of solar panels, is importing 340-390 tons of silver monthly.

Related podcast: Gold Hits New Record, Silver Climbs – Here’s What’s Happening

Despite these bullish fundamentals, silver prices have been somewhat constrained by declining investor demand and potential manipulation in the futures market. However, physical silver shortages and high premiums on coins and bars could return as industrial demand continues to grow.

Investment Implications

Given the long-term trends supporting a commodity supercycle, investors may want to consider increasing their exposure to this asset class. Some key points to consider:

1. Consolidation Phase: The commodity sector is currently in a consolidation phase, partly due to concerns about economic slowdowns in China and the U.S. This may present buying opportunities for long-term investors.
2. Undervaluation: Many commodity-related stocks, particularly in the energy and mining sectors, are trading at low valuations with attractive dividend yields.
3. Precious Metals: Gold and silver have outperformed many other asset classes in recent years and may continue to do so. Silver, in particular, appears undervalued relative to gold.
4. Physical Ownership: Investors may want to consider owning some physical precious metals as part of their portfolio. However, be aware that premiums on coins and bars can be high during periods of strong demand.
5. Mining Stocks: As commodity prices rise, mining companies often see outsized profits due to their operational leverage. This sector could see significant institutional interest as the cycle progresses.
6. Energy Stocks: Despite the push for renewable energy, oil and gas companies are likely to remain profitable for years to come. Many are trading at attractive valuations and offering high dividend yields.
7. Copper and Battery Metal Exposure: Companies involved in copper mining or the production of metals essential for batteries (lithium, nickel, cobalt) may benefit from the electrification trend.

Risks and Considerations

While the case for a commodity supercycle is compelling, investors should be aware of potential risks:

1. Economic Slowdowns: Global economic weakness could temporarily dampen demand for commodities, leading to price volatility.
2. Technological Disruptions: Advances in technology could reduce demand for certain commodities or make previously uneconomic sources viable.
3. Policy Changes: Government policies related to climate change, mining regulations, or trade could impact commodity markets in unpredictable ways.
4. Market Manipulation: Some commodity markets, particularly in precious metals, have been subject to manipulation allegations which could affect short-term price movements.
5. Currency Fluctuations: As many commodities are priced in U.S. dollars, changes in currency values can impact commodity prices and profitability for producers.

Conclusion

I believe the commodity supercycle thesis remains intact, supported by long-term trends in global population growth, emerging market development, and the ongoing transition to decarbonization, alongside the global shift towards renewable energy. While we may currently be in a consolidation phase, the fundamental supply-demand imbalances in key commodities like oil, copper, and silver point to the potential for significantly higher prices in the years ahead.

Investors looking to capitalize on this trend should consider building positions in undervalued commodity-related assets during periods of weakness. However, it's important to maintain a long-term perspective, as commodity markets can be volatile in the short term. Diversification across different commodities and related equities can help manage risk while positioning portfolios to benefit from the potential supercycle.

As always, investors should conduct their own research and consult with financial professionals to determine the appropriate allocation to commodities within their overall investment strategy.

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To listen to this podcast conversation, see Commodity Supercycle: Derailed, Delayed, or Unfolding as Expected?.

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