The incredibly strong run we have seen from commodities over the last 12 months has led a number of commentators to suggest that we are seeing the beginnings of a commodities ‘super-cycle’. 
Attitudes towards commodities in recent months have clearly shifted. Having gone through a 10-year bear market, there is undoubted positive sentiment towards commodities at present, and this is being reflected in corresponding equity valuations.
At this stage, it is too early to say whether we are in ‘super-cycle’ territory. However, after such a long bear market, I would suggest that this question should be a secondary consideration, albeit an interesting one.
More critical is understanding the major trends that are influencing sentiment towards commodities markets at the moment and, in particularly, which ones are simply transitory and which are likely to continue for the long term.
Are inflationary pressures structural or simply transitory?
Inflation is the biggest issue and concern for investors at present, with the combination of fiscal stimulus, central bank policy and lockdown easing contributing to sharp increases.
Most recently, at the end of May, the US Commerce Department’s core personal consumption expenditure index, an important US inflation measure that is watched carefully by the Federal Reserve, posted its biggest year-on-year jump since the 1990s.
Much has been written about inflation, albeit with little conclusion as to whether this is a short- or a longer-term concern. From its perspective, the Fed’s stated position is that it expects these inflation pressures to be transitory. This might be true in some ways but, in others, it looks much longer term.
From a commodities perspective, we can certainly see a number of transitory drivers. Virus-related supply disruptions across mining and manufacturing; pent-up demand from higher savings rates during Covid-19; disrupted supply chains; and accommodative government policy are all playing their part.
However, there is also an extensive list of longer-term drivers that needs to be considered: green energy policy; the results of low investment in new supply in the mining sector on the back of a ten-year bear market; and China shifting away from polluting industries are all themes that will be with us for the foreseeable future and will continue irrespective of economic conditions.
In such a context, while too much near-term inflation would be negative for commodities, given the knock-on effect to the general economy, a dampening in these longer-term pressures would certainly be welcome.
The impact of environmental focuses
The environmental theme is perhaps the most powerful trend in commodities today.
China, a huge consumer of commodities, is a good example: having been the ‘factory of the world’, China is now visibly scaling back on polluting industries. This environmental focus has certainly not been driven by a desire for popularity; it has been instigated by the need to alleviate systemic risk to the country and its population. Supply and demand dynamics for commodities have inevitably been disrupted as a result.
Environmental considerations, in combination with other factors, are also exercising influence in other ways and impacting on supply and demand. It is far harder to permit a new mine, for example, than ever before, which has clear implications for a number of commodity assets.
At the same time, global government policy and efforts to stimulate economic recovery from Covid through infrastructure spending, low interest rates and generally ‘easy’ monetary policy are having an impact. A major tilt towards green energy is also evident, as evidenced by evermore ambitious carbon emissions targets as we approach the COP26 conference.
All commodities are not the same
Supply and demand ultimately drives all commodities. However, dynamics for each are different and so it is important to consider each on an individual basis.
Nickel is often cited as a key input into batteries for electric vehicles – is a good example. Currently in a small surplus, about 90 per cent of its demand at present comes from stainless steel production. However, the rapid expansion of nickel pig iron provides a cheap and easy substitute within stainless steel production, has had a significant impact on demand and a surplus of supply. This is likely to remain a major feature over the next few years, at least until electric vehicles become a larger component of demand.
In contrast, the outlook for copper is particularly positive: it is key to all forms of electrification, with very few alternative options available. Given that the lead times for new mines are long, and have been extended further due to underinvestment and the difficulties in permitting new projects, a tightening of copper supply appears likely, which will impact prices.
For different reasons, uranium is seeing a similarly positive outlook. As the only zero-source of base load power, nuclear power has been supported by global political shifts with the build-out of new reactors in China and life extension of existing reactors in the west. Having seen low uranium prices lead to significant supply closures, prices must now move higher to stimulate the additional supply needed to meet requirements for uranium and resulting nuclear power sources.
The role for commodities in portfolios
There is a strong case for allocating to commodities, though investors need to consider the different long-term dynamics and the resulting attributes that different assets can bring.
Physical demand for gold has remained strong, in no small part due to continued uncertainty – be this the appearance of Covid variants; ballooning global debt levels; or the continuation of loose monetary policy (with no apparent clear plan to exit this). The longevity of these trends remains open to question but, in such a context, precious metals, for example, can be a useful diversifier.
As such, the question of a commodities ‘super-cycle’ is, at least today, a bit of a misnomer. Investors would be well advised not to think in these terms, instead consider the extent to which current trends are actually structural in nature and, in that case, what role different commodities can play in meeting their long-term goals.
Rob Crayfourd is portfolio manager at New City Investment Managers. The views expressed above are his own and should not be taken as investment advice.