The stars may be aligned for a new cycle of rising prices for industrial and agricultural commodities. It has been nine years since the 2002-2011 “supercycle” peaked, and the malinvestment and overcapacity from that period has been largely washed out. Over the past several months, despite economic recession around the world, commodity prices have started to rise in response to supply disruptions and the anticipation of a strong global synchronized recovery in 2021. Moreover, in recent weeks the victory of Joe Biden in the U.S. elections has raised the prospect of a combination of loose monetary policy and robust fiscal policy, with the added benefit that a good part of the fiscal largess will be directed to infrastructure and “green” targets which will increase demand for key commodities. Finally, global demographics are once again becoming supportive of demand.
The chart below shows 25 years of price history for the CRB Raw Industrials Spot Index and the Copper Spot Index. Not surprisingly, these indices follow the same path. Interestingly, they are also closely linked with emerging markets stocks. This is is shown in the second chart. (VEIEX, FTSE EM Index). This is clear evidence of the highly cyclical nature of EM investing, and it is the explanation for why EM stocks outperform mainly when global growth is strong, commodity prices are rising and the USD is declining.
Since the early 2000s, China has been the force driving global growth and the cyclical dynamic. Since that time China has been responsible for generating most of the incremental demand for commodities. Starting in 1994, China embarked on a twenty-year stretch of very high and stable GDP growth which took its GDP per capita from $746 to $7,784. In 1994, China’s GDP/capita was in line with Sudan and only 15% of Brazil’s. By 1994, China’s GDP/capita reached 65% of Brazil’s. By 2018, China had surpassed Brazil.
By the turn of the century, China’s coastal regions which dominate economic activity had already reached the transformation point when consumption and demand for infrastructure and housing result in a surge of demand for commodities. This transformation point typically occurs around when GDP/capita surpasses $2,000, which happened for Brazil in 1968 and in Korea in 1973. In 2005 China’s overall GDP/capita reached $2,000 and the commodity super-cycle was well under way. (All GDP/capita figures cited are from the World Bank database and based on 2015 constant dollars.)
Moreover, China was not the only significant country to enter this commodity-intensive phase of growth during the 2000s. The chart below shows the list of new entrants to the $2,000/capita club since the late 1960s. During the 2000s, three large EM countries, Indonesia, the Philippines and Egypt, also broke the barrier. These three countries added fuel to the commodity boom created by China’s hyper-growth and infrastructure buildout, generating the commodity “supercycle.”
The historical link between rising commodity prices, a falling dollar and the incorporation of large amounts of new consumers into the world economy can be seen in the following three charts which cover the 1970-2020 period.. The first chart shows the rolling three-year average of the total annual increase in the population of global citizens with an annual income above $2,000. The second chart shows the increase in commodity prices relative to the S&P 500; and the third chart shows the evolution of the nominal effective U.S. dollar. The connection between the three charts is clear: every period of rapid growth in new developing world consumers coincides with both rising commodity prices and a weaker USD. Not surprisingly, every bull market in EM stocks (1969-1975, 1987-92, 2002-2010) also follows this pattern.
The bull case for emerging markets investors today is that we are on the verge of entering a new cycle as five more countries pass the $2,000/capita barrier. Already this year, Kenya and Ghana will reach this level. These two countries in themselves are not that significant but they point to the importance of Africa for the future. Then in 2021 India (pop. 1.4 billion) reaches the benchmark, followed by Bangladesh (pop. 170 million) in 2022. The following chart shows the evolution of the total global population with per capita GDP above $2,000 and the annual increases for the past 50 years and the next five years. The potential significance of India and Bangladesh are clear.
India will likely have an impact on a different set of commodities than China had. India is unlikely to achieve the pace of infrastructure growth that China had, and has significant iron ore resources. This means the impact on iron ore and other building materials will not be as great. On the other hand, India imports most of its oil and will have an increasing impact on the oil markets. India also faces great urgency to electrify the country and to do this with clean energy. This points to growing demand for copper , cobalt and silver, three markets that already appear to be undersupplied in coming years.