Wheels Are Falling Off the Supercycle

By LIAM DENNING
Have we fallen off the cycle or is the bike broken?
Since 1998, commodities have been in a bull marketthe so-called supercycle,
where surin demand for raw materials eclipses supply, !uicin prices to abnormal
hihs"
#ately, thouh, it has been all downhill for commodities" $n %oran Stanley&s%S -
'"()* recent earnins call, finance chief +uth ,orat characteri-ed this weakness as
cyclical rather than structural" .ut a more fundamental shift appears under way"
/wo thins underpinned the upswin in industrial commodities" 0irst, low prices
discouraed investment in new oil fields and mines throuh most of the 198's and
199's" Second, demand in emerin markets, especially 1hina, !umped"
2either factor will hold this decade in the way they did durin the last"
Hih prices have encouraed investment in new supply" /he most obvious e3ample is
the rebound in 4"S" oil-and-as production" 5lobally, spendin on oil-and-as
resources is forecast by consultancy 6HS Herold at almost 7('' billion this year, more
than four times the level of 1' years ao"
Somethin similar is happenin with industrial metals and minerals" 1aterpillar 18/ -
'"98* !ust cut its uidance, citin weak demand for minin e:uipment" ;3cess
capacity has weihed on aluminum for years and has started hittin iron ore"
#ately, it&s been all downhill for commodities"
2ow, copper is startin to feel the effects" .arclays .8+1"#2 -'"9<* estimates lobal
copper supply outpaced consumption last year and will continue to do so at least
throuh ='1), reversin the deficits of ='1' and ='11" 6nventories of copper are
buildin, and it is noteworthy that >"," %oran 1hase and others now want to launch
copper-backed e3chane-traded fundsone way of wrinin profits from piles of idle
metal"
>ust as supply accelerates, rowth in demand has softened" Sluish rowth and
enhanced fuel efficiency, especially in the 4"S", mean the 6nternational ;nery
8ency e3pects oil demand in advanced economies in ='1( to be lower than in 199("
0or oil bulls, 1hina is the reat offset to this" 6n the decade ended in =''(, it
accounted for =9* of oil-demand rowth" /wo other centers of rowth in oil demand
are the former Soviet 4nion and the %iddle ;ast" #ookin to ='1(, the 6;8 e3pects
their combined demand to rise faster than 1hina&s" ?et these two reions& economies
are heavily tied to enery e3ports, so estimates for their oil consumption rise and fall
with 1hina&s fortunes"
$il consumption in 1hina over this decade is unlikely to repeat the sure of the last
one, when it almost doubled" 6n that earlier period, 1hina burned between one and
1"< barrels of oil per 71,''' of real ross domestic product, accordin to +aymond
>ames" .y ='1=, that had slipped below one barrel"
1hina&s 5@, rowth has slowed as e3port markets, especially ;urope, have
weakened" 6n addition, .ei!in is pushin to move the economy away from fi3ed-asset
investment, currently half of 5@,, toward consumption, which accounts for only about
one-third" /his shift will represent a fundamental restraint on rowth"
%etals demand could fare even worse in this scenario, iven how closely it is tied to
1hina&s construction bine" 0or e3ample, between =''< and ='1', 1hina accounted
for 1<'* of lobal copper-demand rowth, reflectin declines in other countries" 0or
the period from ='1' to ='1), .arclays estimates that dependency will remain hih,
with 1hina accountin for 99* of net rowth"
/he wild card is a potential 1hinese Ahard landin"A #onview ;conomics points to
surin leverae, estimatin 1hina&s private sector now needs rouhly 79 of
borrowin to enerate 71 of e3tra 5@,, more than ="< times the level that prevailed
before the financial crisis" /he risk of a credit bubble poppin, and 1hinese economic
rowth stallin out, is clear"
0acin a more difficult environment in this decade, commodities investors also must
also another hard truthB ;ven the last decade wasn&t an unalloyed success"
0unds trackin inde3es such as the SC, 5S16 present the easiest way to buy a
basket of raw materials, often in the form of futures contracts" ,roblem is, unlike
stocks, commodities yield nothin" 6ndeed, the process of sellin e3pirin futures
contracts and buyin new ones to maintain positions can impose substantial costs"
/he total return on the SC, <'' has beaten three bi commodities inde3esthe
5S16, the /homson +euters 1ontinuous 1ommodity and @ow >ones-
4.S 4.S2"DE F'"91* over one-, two- and five-year periods"
$n a si3-year-to-1<-year span, the +euters inde3 beat the SC, <''" So an investor
who bouht the +euters inde3 anytime between 1998 and =''(, the best of the
commodities upswin, would have done better than holdin stocks" .ut even lookin
back across that period, the SC, <'' still beats the 5S16 and, across most time
periods, the @>-4.S inde3es, likely reflectin different weihtins of commodities in
each inde3"
8nd, unfortunately, investors& timin hasn&t been the best" $f 79=G billion, net, that
flowed into commodity-linked products between =''' and ='1=, half came between
=''8 and ='1', accordin to .arclays" #oose monetary policy in response to the
financial crisis prompted a rush into hard assets, but returns have laed behind that
of stocks"
,lus, as old&s recent selloff showed, investors appear less worried about inflation
and more about securin some yield from their assets"
/here is still money to be made in commodities" .ut this will re:uire active
manaement, market knowlede and timin" /hat is more suited to the skills of
speciali-ed traders than the buy-and-hold inde3 investin that took off over the past
decade or so" /his eneration&s olden ae of commodities is over""
Write to #iam @ennin at liam"denninHws!"com
Corrections & Amplifications
/he /homson +euters 1ontinuous 1ommodity inde3 is one of the three bi
commodities inde3es" 8n earlier version of this column incorrectly ave the name as
the /homson +eutersI>efferies 1+."