There’s nothing like a big round number to concentrate the mind. Investors, in particular, have a tendency to get excited about arbitrary price points with an abundance of zeroes. Think the 1999 best-seller ‘Dow 36,000’ (we’re still waiting but not for long, I suspect).
Last week’s big round number was 10,000 - the price in (US) dollars for a tonne of copper. It was the first time the metal, which is used in everything from kettles to electric vehicles and wind turbines, had fetched that price since the peak of the last industrial metals upswing in 2011.
When you consider that you could have bought a tonne of copper for US$4,300 a year ago, the recent rise is quite something. It is hardly surprising that talk of a commodities boom is picking up. And not just any old rally; what’s getting investors excited is the prospect of a commodities supercycle.
Most industries are cyclical to an extent, but commodities are more so than most because the price of metals, crops and energy are closely tied to real day to day supply and demand. The price of a share can be sustained by hopes for future growth in earnings, but the cost of a tonne of copper reflects the balance of buyers and sellers today.
This means that commodities are always moving in mini bull and bear markets. Rising demand and constrained supply pushes prices higher and that, in turn, creates the oversupply that brings the market back into balance.
A supercycle is different. It is always driven by some kind of structural change in which demand is transformed over a period of many years, and usually all around the world at the same time. The mass production of motor cars in the early part of the last century, and then the growth of aviation, fundamentally changed the supply/demand dynamic for oil, for example.
Commodity supercycles are not that common, but when they kick in they last for years. There have probably only been four proper ones in the past 150 years. The first was triggered by American industrialisation and urbanisation, fuelled by the US’s railway boom and accelerated by the First World War’s demand for armaments.
The causes of the other three are well-known: the post-war recovery in Europe and Japan; the 1970s oil shock, boosted by Lyndon Johnson’s Wars on Poverty and in Vietnam, and the space race; and China’s rapid growth after it joined the World Trade Organisation in 2000.
So, the big question today is whether the recent price signals, from copper (which has doubled in a year), iron ore, nickel, zinc and other metals, indicate a temporary upswing as the world emerges from the Covid pandemic or the start of something more substantial. The answer to that question may well be one of the most important for investors today.
It’s easy to make the case for a short-term bull market in commodities. The economic data around the world in recent weeks has surprised economists if not stock market investors who identified the possibility of a V-shaped recovery in activity a year ago. Coupled with short-term supply interruptions due to the pandemic, and longer-term constraints thanks to a decade of falling prices, it’s no surprise that prices should have bolted in recent months.
What’s more interesting, however, is the potential for that all-important multi-decade shift in demand. And for that you need look no further than the twin drivers of Joe Biden’s transformational spending programme and the energy transition that has the potential to absorb however many trillions of dollars the world’s big-spending governments want to print.
A third of Biden’s so-called American Jobs Plan is earmarked for transport infrastructure and electric vehicles. China, too, has decided that electric vehicles will be the mainstream option within 15 years. Here in Europe, time has already been called on the internal combustion engine over the next decade or so. By 2040, Wood Mackenzie forecasts, there could be 300 million electric vehicles on the world’s roads. In 2019 there were 5 million.
And that is just cars. Factor in green energy generation, let alone the once in a hundred years rebuilding of crumbling infrastructure on both sides of the Atlantic, and the demand for green metals like copper, nickel, aluminium and platinum is likely to soar. Glencore, the commodities trader and mining company, thinks demand for copper could double in 30 years.
Importantly, capital investment in new capacity is well below what is needed to meet that growth in demand. Of the more than 200 big copper deposits to have been found in the past three decades, only a handful have come in the last 10 years. Only 80 or so are now in production or have been closed. It takes years to develop a copper mine and in recent years shareholders have encouraged the payment of dividends over preparing for a future boom.
So, how might investors position themselves for the supercycle ahead? The simplest and cheapest way is via a commodities-focused exchange traded fund. There are plenty of different flavours but a broad-based exposure to metals and energy makes sense. To turbo-charge returns in the event of a prolonged upswing, investing directly in commodity producers is a better idea. With relatively fixed costs, miners’ and oil companies’ earnings will rise more quickly than the price of their underlying resources.
The other advantage of investing in commodity-related shares is that they can also deliver a high and sustainable dividend income. The combination of price gains and re-invested dividends over the duration of a typical supercycle might point you towards your own big round number.
Tom Stevenson is an investment director at Fidelity International. The ideas are his own. He tweets at @tomstevenson63.
