Gold, silver and the commodities supercycle

As a general rule, the most successful man in life is the man who has the best information

 

2020.12.10

On Tuesday, Nov. 24 copper prices hit a fresh 2020 pinnacle of $3.52 per pound on the Comex in New York. The red metal’s best performance in seven years was on the strength of Chinese manufacturing and construction expanding at its fastest in a decade. The country’s manufacturing PMI for November, seen as a leading indicator of copper usage, rose to 52.1 while the Caixin manufacturing PMI, which includes both large and small firms, jumped to a 10-year high of 54.9. Any number above 50 indicates an expansion. The construction index leapt from 59.8 in October to 60.5.


Iron ore has also been on a tear, last Friday hitting $146.93 a tonne, a seven-year high.

The numbers are so good, some market observers are pulling up charts from the “mining supercycle”. Reuters quotes Goldman Sachs predicting a return to the “structural bull market” of the 2000s, when most mined commodity prices got a lift due to demand (especially in China) outstripping available supplies. In a report the investment bank states:

“Covid is already ushering in a new era of policies aimed at social need instead of financial stability [which] will likely create cyclically stronger, more commodity-intensive economic growth, that should create the elusive cyclical upswing in demand.”

Metal traders say copper is looking like it did at the start of the ’03 supercycle start, having surged this year on a wave of bullish factors including a weak dollar, optimism over covid vaccines, a move toward low-carbon power sources, and virus-related supply disruptions in the key copper-producing countries of Chile, Peru and Mexico. Prices are up more than 70% from a mid-March low, and Morgan Stanley predicts a substantial increase next year, to an average $7,716 a ton ($3.85/lb) in the fourth quarter.

However unlike the previous supercycle, which depended on China, Goldman says the next structural bull market will be driven by spending on green energy, for which copper is a key ingredient:

“Spending on green infrastructure could be as significant as the BRIC (Brazil-Russia-India-China) investment boom of that decade while the redistributive push in developed markets “is likely to lead to a large boost to consumer spending, comparable to the lending-fuelled consumption increase in the 2000s.”

In a recent article we proved that copper is the most critical of all critical metals, because of its necessity in electrification, and the fact that there is an actual shortage of copper coming.

There is no shift from fossil fuels to green energy without the red metal, which has no substitutes for its uses in EVs (electric motors and wiring, batteries, inverters, charging stations) wind and solar energy, and 5G.

Even with a 30% penetration of EVs, a relatively conservative estimate, we need to find another 20 million tonnes per year over 20 years.

Plus we, still need to cover all the copper demanded by electrical, construction, power generation, charging stations, renewable energy, 5G, high-speed rail, etc., plus infrastructure maintenance/ buildout of new infrastructure.

That might be another 5-7Mt. So not only is there a 20Mt increase in copper usage required for a 30% EV penetration, but another (we estimate) 5-7Mt increase to meet demand for all of copper's other applications. To keep up, the industry will need to find an additional two to three Kamoas a year [referring to the massive new copper mine being built in the DRC], each producing 500,000t, for the next 20 years!

Remember — over 200 copper mines are expected to run out of ore before 2035, with not enough new mines in the pipeline to take their place. It’s going to be hard enough to keep up the current 20Mt per year, let alone add so much more production.

But what if the impending copper shortage is a symptom of an even bigger problem, or opportunity, depending on whether a company is buying metals or selling them? That it isn’t just copper that is going to have trouble meeting demand, and whose price will rise accordingly, but a host of other mined commodities? For example zinc, nickel and iron ore have all done quite well this year. Iron ore is up 57%, year to date, lead recently hit a one-year high on mine disruptions, zinc is up 50% since its March low point, and in mid-October, nickel hit an 11-month high, according to Reuters, as expectations of robust demand from stainless steel mills spurred fresh purchases, while industrial metals overall were supported by a lower dollar and healthy growth in top consumer China.


Source: Markets Insider

Currently the bulk of metals demand is coming from China, which has emerged from the pandemic and is doing a roaring trade. In September, the country reported a 13.2% surge in imports and exports rising 9.9% compared to the same period a year ago. That month’s combined imports and export reached a record amount in Chinese yuan-denominated terms. 

Many Western countries are still in the grip of the pandemic, including the US and Canada, experiencing a brutal second wave of infections, but what happens when vaccines start getting distributed? Assuming they work, curves will flatten, hospitalization rates will decline, restrictions will ease, businesses will re-open, and a good percentage of unemployed workers will return to their jobs, or get new ones.

Change will be gradual, but eventually, optimistically by mid-2021, economies will come around. And that, we predict, could signal the beginning of a new commodities supercycle, possibly even besting the 2000s commodities boom.

What will that mean for gold and silver prices?

Gold and supercycles

Students of previous commodity bull market cycles know that gold is usually the first metal to move, in a synchronized commodities upswing. That’s because gold is the first commodity to react to an increase in the money supply. It is no coincidence that gold soared 35% from mid-March lows, to a record $2,034 per ounce in August, due primarily to inflation expectations on the back of seemingly unlimited monetary stimulus, and low interest rates worldwide.

Two important catalysts for gold are a falling currency, and real or perceived inflation. Inflation could result from an increase in the M2 money supply, which has climbed around 21% since March, although it hasn’t happened yet. The current US inflation rate sits at 1.2%.


M2 money supply, December 2019-present. Source: Board of Governors of the Federal Reserve System

However, other overlooked scenarios for inflation to rear its ugly head are:

  • Supply constraints in the economy. When an industry, or industries, fail to deliver enough goods for their market, the result is price inflation.
  • An over-reliance on imported goods can also cause price inflation.
  • The prices of goods can increase if labor disruptions occur.
  • When countries fail to coordinate their internal/ external emergency policies, and instead, act unilaterally.

We are seeing all of this in our current coronavirus predicament. Currency debasement is also a very real phenomenon. From a mid-March high of 102.82, the US dollar index, or DXY, has fallen 13%.


US Dollar Index, year to date. Source: MarketWatch

The dovish response of the US Federal Reserve to the pandemic, in keeping interest rates near zero and blowing out its balance sheet beyond $7 trillion, not to mention the trillions in covid-19 rescue funds spent by the federal government, has a growing chorus of analysts suggesting that the greenback’s status as world currency is in jeopardy.

We covered that topic in a previous article — suffice to say that the dollar is likely to be pressured, so long as the United States battles the coronavirus, with further depreciation likely even if the economy starts to recover.

According to a September article in International Banker,

[T]he US could lose all of those perks as a weak coronavirus response, long-term persistence in implementing quantitative easing (QE) and ultra-low interest rates, and concerted drive to encourage higher inflation all conspire to threaten the dollar’s hegemonic influence around the world. Goldman Sachs, for instance, issued a stark warning that the dollar is in serious danger of losing its reserve-currency status. The US bank’s concerns are primarily related to the massive monetary injections into the economy by the Federal Reserve, the balance sheet of which has now topped a staggering $7 trillion thanks to the reintroduction of its quantitative-easing policy as well as the fiscal stimulus provided by Congress.


Source: Board of Governors of the Federal Reserve System

We can say with confidence that gold has gained during most of the last several recessions, as the chart below shows, and that the yellow metal usually performs best in contractions accompanied by uncertainty and a weak US dollar, high inflation or low interest rates. (which basically describes the current environment, minus the high inflation)

Recessions and contractions are part of the regular business cycle, which on average, last about seven years.


Historically, higher gold prices have tracked recessions. Source: Sunshine Profits

Another major trend, identified by Sunshine Profits, is to envisage gold prices as two bull markets and two bear markets:

The first bull market occurred in the 1970s due to the collapse of the Bretton Woods system and the inflationary oil crisis. In the 1980s and the 1990s, the U.S. economy flourished, while the greenback strengthened, so the yellow metal entered its first bear market. In the 2000s, the confidence in the American economy and its currency dropped, and gold reached [a record high of $1,900/oz] in 2011.

Gold then slipped into a bear market from 2012 to 2016, the year it began rising again, due to a number of factors including a weak stock market, a slowdown in China and low oil prices. Few need reminding that, apart from a brief dip earlier this year, owing to virus-related market panic, gold prices have kept climbing, reaching an all-time high on Aug. 4 of $2,022.66/oz.


Gold slipped into a bear market from 2012 to 2016. Source: Sunshine Profits

Silver, despite being as much an industrial as an investment metal, follows a similar pattern to gold, in that there are two silver bulls and two silver bears.


Silver approached $50/oz in April 2011, a level not seen since 1980. Source: Sunshine Profits

From this we can make an astute observation. Gold correlates less to swings in the economy than oil and industrial commodities, which makes sense. Demand for gold is almost purely investment-related, unlike say, oil and copper, which are heavily influenced by economic growth. But when there is a correction in the gold price, either to the upside or downside, it tends to be long-lasting.

For example, while gold crashed within two years, from $850/oz in 1980 to $300/oz in 1982, it took another 20 years for gold to clamber above $300/oz in 2002. For the next eight years gold was in a bull market, punching through $1,900 for the first time in 2011. The current gold bull market began in 2016 and has not stopped, nor is it expected to; we’ll get into that in the last section.


Gold bumped along around $400/oz for 20 years, before rising sharply in 2003, the start of the last commodities supercycle. Source: Goldprice.org.

2000s commodities boom

Earlier in the article we suggested the global economy could be at the beginning of a new commodities supercycle, possibly even besting the last mining supercycle, the 2000s commodities boom, evidenced by surging prices of a number of industrial metals, including iron ore, copper, lead and zinc, as well as booming Chinese economic growth, post-pandemic.

The supercycle is seen dramatically in the chart below of the S&P GSCI Commodity Index. Commodities in the index show a rapier-like spike from December 2006 to January 2008, then take a 21-year tumble the same year, the plunge in demand due to the Great Recession. Over the next two years, however, from March 2009 to March 2011, GSCI surged 73%.


Source: Trading Economics

The 2000s were marked by the rise of many commodity prices including food, oil, metals, chemicals and fuels. Economic historians see this time as a reaction to the “Great Commodities Depression” of the 1980s and 1980s. Comparable to the commodities supercycles that accompanied the post-World War Two economic expansion and the Second Industrial Revolution in the second half of the 19th century and early 20th century, the boom was largely the result of rising demand from emerging markets particularly China, from 1992 to 2013, as well as concerns over long-term supply.

A number of commodity price bubbles formed during this period. For example a rising global population and a sharp decline in food crop production, were two factors behind a marked increase in the prices of basic food stocks. Strong demand in India and Egypt helped ramp up demand for American wheat in 2007, and in 2008, wheat prices reached record highs after Kazakhstan limited supplies sold overseas and Russia banned exports due to a drought that destroyed its wheat and barley harvests. Food riots hit Egypt, after national bread prices rose rapidly in March and April of 2008.

Rice prices gained to US$0.24 a pound, more than doubling in just seven months.

The most important commodity in the running of the global economy, crude oil, famously climbed from $30 a barrel in 2003, to a July 2008 peak of $147.30, (gas prices across the US surpassed $4 a gallon) before the financial crisis severely crimped energy demand, resulting in a dramatic tumble in oil prices, to a December 2008 low of $32.

How did gold and silver fare during this last commodities supercycle? Quite well as it turns out. Between 1999-2001, gold prices were near the end of a 20-year bear market that began to correct in 2002 when prices climbed above $300/oz. This period has become known as the “Brown Bottom”, during which time the UK government Treasury, on the orders of then-Chancellor of the Exchequer Gordon Brown, foolishly sold all of the British government’s gold reserves — which then accounted for around half of the UK’s $13 billion foreign currency net reserves.

Gold prices climbed steadily since 2003, on the back of increased demand for bullion and a weak US dollar, reaching a 20-year high of $865.35/oz in January, 2008. Gold rallied further in 2010, after the EU debt crisis prompted many investors to rotate funds into gold as a safe-haven asset, hitting a then-record in December 2010 of $1,429/oz, before continuing on to its 2000s supercycle peak of $1,900/oz in August, 2011.

Silver prices followed a similar trajectory. In 1992 silver cost $4 per ounce, but in 2004, corresponding to gold’s move up, the white metal caught a bid, and by late 2007, had more than quadrupled to $18/oz. During the financial crisis silver prices were cut in half, however they started back up again in early 2009. By February 2011, silver was averaging $30 an ounce. Two months later, it neared a record $50/oz, but like gold, the high was temporary. In June 2011 silver prices were again cut in half, before falling to a seven-year low of $13.91 in December 2015. Gold’s fall from grace came a bit later. After a dramatic sell-off in April, 2013, suffering its worst-ever one day loss of $125/oz, the yellow metal stagnated for a couple of years, reaching a bottom of $1.066.10 in December 2015.


Source: Kitco


Source: Kitco

Supercycle theories

What accounts for commodity supercycles? There are a number of theories. Two of the most famous are the Kondratieff Wave, named after Russian economist Nikolai Kondratieff, and the work of Joseph Schumpeter, writing in the 1930s.

As the most famous supercycler, Schumpeter claimed to have found three commodity cycles, each with an upswing of 30-40 years, peak to trough. The first cycle, goes the theory, matched the Industrial Revolution in the United Kingdom that ran from 1786 to 1842. The advent of “coal, iron, railways, steamships, textiles and clothing” ushered in the second cycle, during which prices peaked around 1873 then started to fall, according to a UN study on supercycles quoted by iPolitics. Schumpeter's third cycle was linked to new technologies coming from “steel electricity, organic chemicals, the internal combustion engine, automobiles,” says the UN study.

Nikolai Kondratieff noticed that agricultural commodity and copper prices experienced long-term cycles. A Kondratieff Wave is a long-term economic cycle believed to be born out of technological innovation, which results in a long period of prosperity. Economists have identified five Kondratieff Wave cycles since the 18th century: the invention of the steam engine (1780-1830); the steel industry and the spread of railroads (1830-1880); electrification and innovations in the chemicals industry (1880-1930); automobiles and petrochemicals (1930-70); and information technology which started in the 1970s and runs to present.

Each of these cycles has four sub-cycles, named after seasons: spring when the cycle is experiencing an economic boom, including an increase in productivity and inflation; summer when an increase in affluence leads to changing attitudes towards work that slows economic growth; autumn stagnation, giving rise to deflation and lower economic growth; and finally winter, when the economy falls into a deep depression that widens the gap between the haves and the have-nots.

According to Investopedia, Kondratieff Waves are part of a branch of economics called heterodox economics, that are not widely accepted by economists. In fact the theory got Kondratieff into deep trouble in his home country. As Investopedia tells it, His views were anathema to communist officials, especially Josef Stalin, because they suggested that capitalist nations were not on an inevitable path to destruction but, rather, that they experienced ups and downs. As a result, he ended up in a concentration camp in Siberia and was shot by a firing squad in 1938.

Research by RBC Wealth Management reveals that over the past 100 years, there have been four great commodity booms — World War I, World War II, the industrialization of Japan and the OPEC embargo, and the industrialization of China. Each followed a long period of demand stagnation, and a lack of investment in new supply. RBC also point to a series of stages that unfold as new demand sources emerge. In the first stage, new demand, such as China’s historic growth starting in the late 1990s, begins to put pressure on global supplies. But mining companies are slow to respond, because there was a lack of investment in new mines/ exploration during the previous down cycle. Therefore in stage 2, new projects are greenlighted and access to capital improves.

Stage 3 begins when demand starts being driven not only by the main event, like Japan’s industrialization, but investment. Supplies begin to catch up, but because it takes seven to ten years to develop a new mine, the catch-up is gradual. The peak of the cycle generally happens in this stage, when commodity prices benefit from high demand and lagging supply.

In stage 4, demand begins to wane, as supply, initiated years prior, begins ramping up. The combination weighs on companies’ balance sheets, and prices begin to fall. The last stage, stage 5, is characterized by supply far exceeding demand, with prices for most commodities dropping below the cost of production. As RBC puts it, Capital flow ceases and companies shift into survival mode. Supply continues to grow for a time as projects started years before continue to reach completion. Investment in new projects all but ceases and higher cost projects are shut down. The industry essentially goes into hibernation until the next demand driver emerges.

Visual Capitalist relies on a similar set of circumstances in crafting its infographic, ‘Visualizing the Commodity Super Cycle’. The text accompanying the infographic defines a commodity supercycle as a recognizable pattern across major commodity groups. Economists believe the upswing phase results from a lag between trends that support commodity demand, and slow-moving supply, such as building a new mine or planting a new crop. The cycle enters a down phase when demand growth slows and adequate supply comes available.

Visual Capitalist’s research used data from the Bank of Canada to reproduce a chart indicating four commodity price supercycles since the turn of the 20th century: 1899-1932, coinciding with the industrialization of the United States; 1933-61, a period beginning with the onset of global rearmament before the Second World War, in the 1930s; 1962-95, corresponding to the reindustrialization of Europe and Japan in the late 1950s and early ‘60s; and the fourth cycle, which began in the mid-1990s with the rapid industrialization of China and runs till present.

Finally, two economists who set out to describe supercycles in a 2012 paper, found four cycles between 1884 and 2010, during which all commodities except oil moved together. According to Bloomberg, via Livemint, The first one peaked in 1917 and ended in 1932, at the bottom of the Great Depression. The second one ran until the 1971 oil shock, peaking in 1951. The third one peaked soon after it started, in 1973, and ran until 1999. The current cycle, according to Erten and Ocampo, peaked in 2010 — though if they had data from the next several years, they might have placed the peak in 2011 or 2012.

The article notes that one potential driver of these supercycles is the interaction of large, unexpected demand shocks, and slow-moving supply responses, ie. similar to the reasons found in the Visual Capitalist infographic. The piece is interesting in that it was written in 2015, after the 2000s commodities supercycle had ended. The author questioned what could be driving the (then-current) downtrend? His answer? a slowdown in China:

All the demand prompted the construction of new production facilities and exploration of new deposits, creating the conditions for a glut. Now, with Chinese development slowing, the metals price cycle may have peaked.

2021 commodities bull?

And now for the section you’ve all been waiting for: what comes next?

As mentioned at the top, Goldman Sachs is forecasting a bull market for commodities in 2021, based on a weaker dollar, inflation and the prospect of additional monetary (US Fed) and fiscal (US government) stimulus. In October, CNBC quoted analysts at the bank predicting a 30% return over the next year for S&P GSCI. They recommend going long in gold, silver, copper, US gas, Brent crude and jet regrade.

The bank reportedly sees upside in non-energy commodities including agriculture and metals, citing tighter supply for the former due to adverse weather conditions, and greater demand from China for the latter — something we are already seeing, as the above-cited stats on Chinese PMIs and trade figures indicate.  

“Given that inventories are drawing this early in the cycle, we see a structural bull market for commodities emerging in 2021,” the Goldman analysts said in a research note.

A key driver for commodities prices going forward is the risk of inflation. According to Goldman, markets are increasingly worried about inflation due to record-high levels of fiscal spending and low interest rates for the foreseeable future. President-elect Biden has promised nearly $5.4 trillion in new spending over the next decade, according to the University of Pennsylvania’s Penn Wharton Budget Model, including $1.9 trillion on education and $1.6 trillion on new infrastructure — roads, bridges, highways and other public structures. That doesn’t include a $2 trillion spend over four years to counter climate change.

“Accordingly, we expect an increased rotation into commodities as an inflation hedge,” the analysts wrote.

Gold naturally will benefit from this shift, given that inflation hedgers have traditionally picked gold as the best vehicle. Goldman Sachs predicts the metal to average $2,300 per ounce in 2021, a considerable lift from the $1,836 per ounce average forecasted for this year.

Conclusion

Looking longer term, it’s interesting to read comments stating that the next supercycle may be quite different from the last one. Visual Capitalist asks: Is this the beginning of a new supercycle? The answer could prove to be prophetic:

[P]ast growth was asymmetric around the world with different countries taking the lion’s share of commodities at different times.

With more and more parts of the world experiencing growth simultaneously, demand for commodities is not isolated to a few nations.

Confined to Earth, we could possibly be entering an era where commodities could perpetually be scarce and valuable, breaking the cycles and giving power to nations with the greatest access to resources.

Indeed we live in a world of finite resources. Without a way to replace all the resources we consume — harvested food, fertilizers, energy, metals, etc. — we are gradually depleting nature’s bounty, at a rate that is unsustainable, long-term. If we keep going, and economies keep growing, we’re eventually going to run out. The problem is made worse by the global population increasing, along with the continuing wants of people in the developed world (“the West”) and in less-developed countries (who are demanding houses, cars, fridges, cell phones, etc.), putting more pressure on our finite resources.

As competition for scarce resources becomes more intense, access to a secure and sustainable supply of raw materials will become the number one priority for all countries. Increasingly we are going to see countries ensuring their own industries have first rights to internally produced commodities and they will look for such privileged access from other countries, in return.

The last commodities supercycle which ended around 2010 was very focused on China. For close to a decade, Chinese growth subsided, as the country focused on shifting from an export-driven economy, “the workshop of the world”, to one in which internal consumption is more important than trade. Now, China appears stronger than ever, being the first major economy to emerge from the coronavirus, with an ambitious Five Year Plan to build the nation into a technological powerhouse; its Belt and Road Initiative which according to Morgan Stanley could reach investments of up to $1.3 trillion by 2027; “Made in China 2025,” a state-led industrial policy that seeks to make China dominant in global high-tech manufacturing; and the ongoing push to build up China’s Military.

But China isn’t the only country with big plans for the “new economy” — one that pivots around clean energy, as governments around the world scramble to re-tool their factories and cities to meet the challenge of decreased emissions necessary to fight the effects of climate change — and high technology including artificial intelligence, computer chips, 5G, etc. 

The European Commission has released a €1.85 trillion recovery plan focusing on “EU Green Deal” initiatives aimed at reaching the eurozone’s net emissions by a 2050 target. The election of Joe Biden is extremely bullish for certain metals, including copper, zinc, nickel sulfides, silver and gold.

We believe global infrastructure plans will move forward, including President-elect Biden’s multi-trillion dollar electrification and 5G plans. Demand for copper will certainly increase. Along with nickel, zinc, silver, graphite, cobalt, etc., all the metals needed for “old school black top” and “green electrification” infrastructure metals.

None if it can be done without mining and metals. The age of electrification will soon replace the oil age, setting up the next commodities supercycle.

Richard (Rick) Mills
aheadoftheherd.com
subscribe to my free newsletter
Ahead of the Herd Facebook

Legal Notice / Disclaimer

Ahead of the Herd newsletter, aheadoftheherd.com, hereafter known as AOTH.

Please read the entire Disclaimer carefully before you use this website or read the newsletter. If you do not agree to all the AOTH/Richard Mills Disclaimer, do not access/read this website/newsletter/article, or any of its pages. By reading/using this AOTH/Richard Mills website/newsletter/article, and whether or not you actually read this Disclaimer, you are deemed to have accepted it. 

Any AOTH/Richard Mills document is not, and should not be, construed as an offer to sell or the solicitation of an offer to purchase or subscribe for any investment.

AOTH/Richard Mills has based this document on information obtained from sources he believes to be reliable but which has not been independently verified. AOTH/Richard Mills makes no guarantee, representation or warranty and accepts no responsibility or liability as to its accuracy or completeness. Expressions of opinion are those of AOTH/Richard Mills only and are subject to change without notice. AOTH/Richard Mills assumes no warranty, liability or guarantee for the current relevance, correctness or completeness of any information provided within this Report and will not be held liable for the consequence of reliance upon any opinion or statement contained herein or any omission. Furthermore, AOTH/Richard Mills assumes no liability for any direct or indirect loss or damage or, in particular, for lost profit, which you may incur as a result of the use and existence of the information provided within this AOTH/Richard Mills Report.

AOTH/Richard Mills is not a registered broker/financial advisor and does not hold any licenses. These are solely personal thoughts and opinions about finance and/or investments – no information posted on this site is to be considered investment advice or a recommendation to do anything involving finance or money aside from performing your own due diligence and consulting with your personal registered broker/financial advisor. You agree that by reading AOTH/Richard Mills articles, you are acting at your OWN RISK. In no event should AOTH/Richard Mills liable for any direct or indirect trading losses caused by any information contained in AOTH/Richard Mills articles. Information in AOTH/Richard Mills articles is not an offer to sell or a solicitation of an offer to buy any security. AOTH/Richard Mills is not suggesting the transacting of any financial instruments but does suggest consulting your own registered broker/financial advisor with regards to any such transactions

No Charge  Newsletter Signup

 

Newsletter Unsubscribe



To contact us please email rick@aheadoftheherd.com

Ahead of the Herd
www.aheadoftheherd.com