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Page added on July 28, 2015

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Michael Lynch: End of Commodities Supercycle?

Consumption

About a decade ago, Goldman Sachs’ Arjun Murti suggested an oil “superspike” might send prices to $105 a barrel.   There were two primary reactions to this analysis, first, that Goldman was just marketing its commodity indices, and second, that he/they were crazy. The former view probably continues to be held by some, the latter, not so much. Mr. Murti’s later prediction that oil might hit $200 didn’t prove out, but the $105/barrel prognostication certainly held up.

(Disclaimer: I have friends at Goldman Sachs and have, in the past, received small amounts of money from the company, but not specifically from Mr. Murti or his department.)

What many overlooked at the time of the initial $105/barrel prediction was that it reflected an estimate of how prices might respond to an oil supply disruption. As such, it was much more reasonable than the predictions of peak oilers like Matthew Simmons or T. Boone Pickens, who thought prices were on a permanent upwards trend because of geological scarcity. Cyclical versus secular trends confound many analysts and even academic economists, and the two should not be confused by those who focus simply on an oil price projection.

In fact, though I have long argued against the notion that resource prices must rise over the long-term, in a 2001 article I made the point that a tighter market meant more volatile, and higher, prices, though without suggesting anything like the levels which subsequently occurred. (I thought prices might average $30/barrel, which is about $35 in 2014 dollars, or about 50% of what we’ve seen since 2001. Still waiting for the Nobel committee to call.)

Now, with the prices of many commodities down sharply, interpretations differ as to what is happening. Some see the 2000s supercycle ending, others a temporary decline due to transient economic weakness. There appears to be an element of truth in both, and historical patterns are illuminating.

The commodity inflation of the 1970s, which included two oil crises, renewed a debate about resources that included the insistence that economics could prove prices would rise exponentially, contradicting the empirical observation that they did not tend to do so.   For oil, prices clearly soared due to political disruptions, despite the insistence of many that supplies were “running out.”

The 2000s saw a revival of this debate, including the flawed peak oil theories that supposedly explained higher oil prices, but higher mineral and agricultural prices confirmed to many the neo-Malthusian belief that resource scarcity was beginning to drive prices, not cyclical elements. Booming economic growth in China was a major driver of both prices and the belief in the inevitability of ever-higher prices. Now that Chinese economic growth has slowed, lower commodity prices causing at least some to rethink this, but the underlying debate remains.

 

Commodity price booms are usually caused by one of three factors: economic growth so rapid that producers can’t initially meet demand, or unusual but temporary conditions that restrict supply, from weather to violent conflicts. Fiscal stimulus can also inflate the balloon, and that certainly seems the case in recent years. None of these leads to permanent changes in sustainable price levels, although too many interpret them as doing so. The higher prices have also meant more supply-side investment which, combined with slower economic growth, has restored market balances, once again proving the adage that “High prices are the solution to high prices.”

And even if economic recovery means more demand, better economic growth should mean less fiscal stimulus, which will reduce pressure on financial assets. At least for oil, this will test the theory that oil prices were elevated because it had become a “safe haven” like gold. If that was a factor, it implies that oil prices will deflate even further, as gold probably will. (Please note I’m not a gold expert; that’s an offhand opinion.)   Another major commodity price cycle seems unlikely in the next few years, given better fundamentals, less problems with supply, and reduced financial stimulus.

Of course, oil is different. Largely coincidental supply disruptions in Iraq, Venezuela, Libya, and Iran kept global supply tight in the 2000s at the same time that roaring demand was pressuring prices, so that a supercycle seems, in retrospect, quite normal. Now, just as food supplies are more normal, oil supplies have caught up and prices retreated, but many are still looking for signs of “price recovery”.

But looking forward, oil still has countervailing pressures. Chinese oil demand growth should return within the next year or two, but at slower rates than in the 2000s, and oil demand areas like Europe and Japan, will not growing strongly, should perform better than in the past several years. Low oil prices will sell more SUVs and less electric vehicles, and even if demand growth doesn’t return to the halcyon years of the mid-2000s, it should help stabilize markets.

Supply is another matter. Political stability has not returned to the Middle East, North Africa or Venezuela. On the other hand, Libyan production cannot go much lower and while both Iraqi and Iranian supply could both surprise on the downside, supply from OPEC countries appears more likely to remain robust than to decline.

For the longer term, I would argue that the decrease in resource nationalism is a major bearish factor, and will continue to depress oil prices (recognizing “depress” is subjective and imprecise). Another oil supercycle is possible but seems less likely than a period of relatively low prices.

Forbes

 



20 Comments on "Michael Lynch: End of Commodities Supercycle?"

  1. BobInget on Tue, 28th Jul 2015 8:36 am 

    One line above is a ‘must read’.

    “Of course, oil is different. Largely coincidental supply disruptions in Iraq, Venezuela, Libya,”

    Again not a single word about the resource that ‘fuels’ war, ‘coincidently’.

    You may have missed news of Turkey appealing to NATO for aid fighting off
    Turkish Kurds who also happen to be the only
    fighters capable of holding ISIS in check.
    If it were not for the PKK, ISIS would have
    Iraq’s Northern oil fields generating funding for common criminals calling themselves “Islamic State”. Turkey also happens to be
    ‘fencing’ a million dollars a day of stolen Iraq oil for IS.
    At some point IS became too ambitious, now Turkey if finally bombing IS as well as PKK.

    Even in America some’drug deals’ go bad.

    “political stability” as Forbes calls wars that have killed over five million and displaced ten times that, “has not returned” to the Middle East or Africa or Asia. As long as oil is in diminished supply, it’s best to minimize all those unpleasantries.

  2. Davy on Tue, 28th Jul 2015 9:05 am 

    Mak, looks like the carnage is not over in Asia. How are things in your overly Chinese dependent Philippines?

    China’s “Manipulated” Market To Plunge Another 14%, DeMark Predicts

    http://www.zerohedge.com/news/2015-07-28/chinas-manipulated-market-plunge-another-14-demark-predicts

    Chinese stocks will decline by an additional 14 percent over the next three weeks as the market demonstrates a trading pattern that mirrors the U.S. crash in 1929, according to Tom DeMark.

    Chinese stocks will decline by an additional 14 percent over the next three weeks as the market demonstrates a trading pattern that mirrors the U.S. crash in 1929, according to Tom DeMark.

    DeMark said he’ll reassess the market once the Shanghai index hits 3,200, which would almost wipe out this year’s gain. If that level, which is around the 61.8 percent Fibonacci retracement from the June peak, fails to hold, the market could “unravel” quickly, he said.

  3. BobInget on Tue, 28th Jul 2015 9:25 am 

    The old adage “when my shoeshine ‘boy’
    asked me what stocks to buy, I went back to the office and sold everything” applies to China.
    IN the long run China’s stock market will regain good value, once Chinese investors learn to understand value. I think comparisons to 1929 crash is a good one.
    It stops there.

    China continues to be exporter to the world. China has developed markets on every continent, marshaled oil supplies well into the century, if able, I would take positions in China’s market .

  4. steve from virginia on Tue, 28th Jul 2015 9:42 am 

    Lynch is certainly entitled to his (very conventional) opinion but he is incorrect when he suggests purchasing power is unaffected by shortages. In Lynch’s world, the ability to bid remains unlimited even if supply falls to zero.

    In reality, supply constraints are mirrored by purchasing power constraints which undermines the bid.

    Customers are excluded from the fuel markets by their lack of access to purchasing power; credit is rationed rather than fuel. The outcome is price declines.

    By the way, once the dynamic of supply declines- leading to price declines becomes entrenched, there is no way to escape it: energy deflation.

    http://www.economic-undertow.com/2013/01/23/net-energy-end-game-theory/

  5. Plantagenet on Tue, 28th Jul 2015 9:48 am 

    We’re in an oil glut. Oil prices will remain low until the supply overhang ends.

  6. davey thompsony on Tue, 28th Jul 2015 10:08 am 

    Thanks for the update planty I was worried the oil glut had ended.

  7. Plantagenet on Tue, 28th Jul 2015 11:09 am 

    @sony

    You’re welcome.

    Yup—no need to worry yet. We’re still in an oil glut.

    Cheers!

  8. davey thompsony on Tue, 28th Jul 2015 11:53 am 

    Yes planty AND you agree with Obama he sez we are in a 100 year glut.

  9. Plantagenet on Tue, 28th Jul 2015 12:03 pm 

    @sony

    Actually, Obama didn’t say we are in a 100 year glut. Obama said we have a 100 year SUPPLY of NG.

    CHEERS!

  10. davey thompsony on Tue, 28th Jul 2015 12:06 pm 

    Yes he did say that the supply is worth 100years at this time. As you say we are in an oil glut(gas included)you agree with Obama.

  11. Beery on Tue, 28th Jul 2015 12:37 pm 

    Davey, stop trolling Plantglutonet, or is it Glutagenet? Plantageglut?

  12. Beery on Tue, 28th Jul 2015 12:37 pm 

    Glutglutaglut?

  13. apneaman on Tue, 28th Jul 2015 12:56 pm 

    Super Cycle? Americans have this peculiar obsession of wanting to make everything seem bigger than it actually is. Attaching the word Super to it doesn’t make your dick any bigger either.

    Super Star, Super Bowl, Super Size, Super Duper, Super Food, Super Hero, Super Pac, Super Sonic, Super Trooper,
    Supercalifragilisticexpialidocious.

    Super insecure?

  14. davey thompsony on Tue, 28th Jul 2015 1:12 pm 

    Yes Beery thank you for keeping me sane. My good buddy planty is WAY to easy to ridicule and I need to stop.

  15. Plantagenet on Tue, 28th Jul 2015 1:27 pm 

    @sony:

    You can stop trolling any time you want.

    You have the willpower to do it.

    Somewhere inside you, in spite of the mess you’ve made of your life, there must still be a shred of decency and character that will allow you to gain control over yourself and stop the trolling.

    Just say no.

    CHEERS!

  16. ghung on Tue, 28th Jul 2015 1:33 pm 

    What’s a genet and how do you plant one. Enquiring minds want to know…

    Anyhow… The world still has too much oil.

    ” China’s crashing stock market and the meltdown in the metals market may be getting all the attention lately, but crude oil is quietly crumbling once again. Oil has plunged nearly 20% this month alone and it briefly dipped below $47 a barrel on Tuesday. That leaves it flirting with the March lows, which was the weakest price since 2009.

    The latest selling has been fueled by the same dynamics that caused oil to tumble from $100 last summer. The American energy revolution has created a massive supply glut and the tepid global economy is depressing demand growth.

    The good news for American drivers is industry insiders expect these dynamics to persist, keeping energy prices cheap for some time. Thousands of U.S. gas stations will have sub-$2 gasoline prices by December, according to Tom Kloza, chief oil analyst at the Oil Price Information Service…..”

    MSM,, keeping a handle on things.

  17. apneaman on Tue, 28th Jul 2015 1:35 pm 

    Super Glut

  18. ghung on Tue, 28th Jul 2015 1:41 pm 

    Massive they said. MASSIVE

  19. davey thompsony on Tue, 28th Jul 2015 1:47 pm 

    Planty my friend, I hope some day you will find peace in your life too. Planty I wish you well my friend.

  20. BC on Tue, 28th Jul 2015 4:04 pm 

    http://www.skil.org/

    http://www.sciencedaily.com/releases/2015/07/150724160616.htm

    http://www.researchgate.net/publication/280088815_Socio-economic_instability_and_the_scaling_of_energy_use_with_population_size

    Energy and population are highly correlated? Who coulda knowed?!

    The 10-year rate of change of increase of global population has decelerated from ~2% in the 1970s to ~1.1% today, which is tracking at an R^2 of 0.986 the log-linear decay trajectory of US oil production per capita of our (US) oil depletion regime since 1970.

    No coincidence.

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