Is the commodities supercycle over?

Short-term rebound off the table


A miner uses a machine to excavate copper ore at the drilling face at the Polkowice-Sieroszowice copper mine, operated by KGHM Polska Miedz SA, in Polkowice, Poland. (Photo: Bartek Sadowski/Bloomberg/Getty)

A miner uses a machine to excavate copper ore at the drilling face at the Polkowice-Sieroszowice copper mine, operated by KGHM Polska Miedz SA, in Polkowice, Poland. (Photo: Bartek Sadowski/Bloomberg/Getty)

When Colorado-based Thompson Creek Metals bought a little-known Vancouver mining junior in 2010, it thought it had struck a motherlode. The target, Terrane Metals, was about to start building a new gold and copper mine in B.C. At the time, gold’s price was at about $1,250 an ounce and climbing. Copper was $3.20 a pound and also rising.

Both metals have since taken a tumble. But the $1.6-billion Mount Milligan mine officially opened a few weeks ago notwithstanding. While politicians and executives were all smiles at the kick-off, the prospects for profits from the mine have plunged from three years ago. Kevin Loughrey, Thompson Creek’s CEO, spoke frankly: “My experience tells me that we will have a couple of [good] cycles. In those years we’ll make very good profits, and in the bad years we’ll scrimp and save to try and get by.”

He’s not the only executive tempering expectations these days. The rise in commodity prices over the past decade prompted some economists, technical analysts and investors to herald a new commodity “supercycle”—an up to 30-year period of high prices for everything from oil to cotton to iron ore. But now, just 10 years into the uptrend, many commodities have fallen on hard times. Whether or not prices will rise again soon is a matter of heated debate. But it doesn’t look likely.

What everyone can agree on is that around the turn of the millennium, emerging-market demand for commodities took off. China especially was industrializing so quickly it overwhelmed the capacity of producers to supply raw materials. “It caught everyone by surprise,” says Rick de los Reyes, a portfolio manager with T. Rowe Price. Since it takes about a decade to develop a mine, supply and demand remained out of balance for much of the 2000s. “That’s why you get a supercycle and why they tend to last so long,” he says. “Once you get that demand shock, it takes a while to get new supply.”

The supercycle was a boon for Canadian investors. Our materials- and energy-heavy market climbed 75% between 1998 and the end of 2009. Over the past three years, though, the pattern changed. While the better diversified S&P 500 has risen 55% since 2010, the S&P/TSX composite is up just 11%.

There are two main reasons for the commodity pullback, says de los Reyes: China’s GDP growth has slowed from about 11% a year to single digits, and supply has finally caught up with demand. Whether the supercycle is over, though, depends on whom you ask. Bearish economists such as Nouriel Roubini and David Rosenberg say the supercycle is dead. Commodity bulls like Jim Rogers and Dennis Gartman think we are seeing a correction before prices resume rising. “It’s ludicrous to talk about an end to a supercycle that only started a decade ago,” Gartman told the Financial Times in August. “[These] are just the sorts of stories that accumulate at the end of a downward move.”

Gareth Watson, GMP Richardson’s vice-president of investment management, is on the side of the bears. If there was a supercycle, he thinks it ended in 2008. Prices rebounded, but the upswing didn’t last, because supply was there to meet demand.

Martin Pelletier, a portfolio manager with Calgary’s TriVest Wealth Counsel, agrees that things are different now. China is moving from a rapidly expanding export economy to a slower-growing, domestic-focused one. Still, he’s not ready to pronounce the supercycle dead. At 7.5% GDP growth, China is still expanding faster than developed nations. An HSBC report released last year predicted more than 500 million Chinese will join the middle class by 2030. “The emerging markets are where we were 50 years ago,” says Pelletier. Their contribution to global commodity demand is far from played out.

Plus there are cost pressures on the supply side. While technological improvements have allowed producers to access resources they couldn’t extract economically before, the deteriorating quality of reserves and rising production costs have put a floor under prices, a report from McKinsey & Co. argues.

Nonetheless history suggests the cycle is indeed pointing down. David Jacks, a professor of economics at Simon Fraser University, has studied commodity prices over the past 113 years and identified three supercycles. The first was during the First World War and lasted five years. The second was in the 1970s and lasted roughly 15 years. We’re in the midst of the third, which he says began in 1998. Based on his research, prices peaked in 2008 and are now on the downward side of the cycle’s curve. It’s likely prices will fall below their long-term averages some time in the next four years, he says. Since 1950, real commodity prices have climbed by 1.5% per year on average. Over the long term, prices will resume their modest rise. “We’ll never get back to 1998, which was this absolute nadir in real commodity prices,” he says. “But it’s not going to be peak 2008 prices either.”

Whatever you believe, returns in commodity sectors will be muted for a while. If you do want to own a materials or energy stock—which you may want to do for diversification purposes—seek out the lowest-cost producer. Bigger players, such as BHP Billiton and Rio Tinto, can produce iron ore for $30 to $40 a tonne, versus $100 a tonne for the highest-cost producers, says de los Reyes. “If iron ore goes to $80 a tonne, that guy will be shut down,” he says.

A clean balance sheet is also important, says Mike Turner, head of global strategy at Aberdeen Asset Management. In a falling-price environment, the less-leveraged operations will outlast their heavily indebted peers, he says. Also look at how management plans to grow or turn around its business.

Another up cycle will arrive at some point, but you may have to wait a decade, says Watson. For now, look elsewhere for returns. “You can definitely make money in the equity markets,” says de los Reyes. “Just don’t buy commodity-levered stocks.”