We've been here before, haven’t we? Perhaps the clamour of Cassandra-like voices was not so great in 2011 when Spear’s previously wrote about the supposedly imminent demise of the commodities super-cycle, but it was nonetheless already a clamour. The past nine months or so have heard that clamour amplified several times over.
The Financial Times declared that the super-cycle was dead at the end of June, only to declare about ten days later that rumours of its death were greatly exaggerated. Most recently, the Wall Street Journal reported that the broad consensus of analysts and investors has called the end of the super-cycle.
But super-cycles tend to die slowly. The first identifiable commodities super-cycle in modern times lasted from 1894 to 1932, peaking in 1917, according to academics Bilge Erten and José Antonio Ocampo. The second lasted from 1932 to 1971, peaking in 1951, and the third lasted from 1971 to 1999, peaking almost as soon as it began.
Given that these three previous super-cycles lasted for twenty years or more, it is hardly unreasonable to expect the current super-cycle to last for another couple of decades.
The current super-cycle, which began in 1999 and may not yet have reached its peak, was founded on China’s urbanisation programme and construction boom, which began in the late Nineties. In 2011 China accounted for 40 per cent of global demand for iron ore and aluminium, 42 per cent of zinc and coal, 43 per cent of copper and lead, and 50 per cent of lean hogs.
If China’s GDP growth drops from around 10.5 per cent to 5.5 per cent over the next few years, as its policy-makers switch into a different growth model based on services and consumerism, will that translate into falling commodity prices?
While many analysts remain bearish, based on the assumption that the Chinese economy will experience a hard landing, Société Générale has come out strongly with a prediction that while gold prices are likely to fall further in 2014, to around $1,050 an ounce, the outlook for commodities will remain positive.
"It would take something dreadful to happen to make the super-cycle suddenly end," Michael Haigh, SocGen’s head of commodities research, told a media briefing in July. If you believe that the current super-cycle "is a function of population and urbanisation, you’re looking at another fifteen to twenty years. But it’s not going to be an upward price for all."
Haigh is not alone. Another analyst who doubts that the super-cycle is over is Eugen Weinberg, head of commodity research at Commerzbank in Germany. "Price movements in the market indicate an end to the commodities super-cycle," he has said.
"But we do not believe the super-cycle is coming to an end. It’s just taking a break. Twenty million people a year move from the countryside to the cities, triggering a huge demand for better infrastructure."
That infrastructure is likely to be more "steel-intense", with the demand for steel in residential construction expected to peak at around 2024, according to the Reserve Bank of Australia, at a level 30 times higher than in 2011.
The switch of those new Chinese town-dwellers to a diet consisting of more animal protein, combined with a global reduction in the amount of arable land, will drive up grain prices, as the cultivation of animal feeds and crops for biofuel compete for land use with other forms of agriculture.
Although the value of gold is not determined by industrial use, its price is nonetheless subject to many more factors than mere investor confidence. The fall in the gold price to well below $1,200 an ounce in June was largely the result of speculative trading in the futures market. (Goldman Sachs is thought to have made 15.5 per cent on its own book as a result of gold’s price fall.)
Meanwhile, central banks around the world have been building up their gold reserves. Russia, Turkey and Brazil have all been big buyers, but the main player has been the People’s Bank of China, which has a long-term plan for the renminbi to supplant the US dollar as the global reserve currency. To achieve that, the People’s Bank needs far greater reserves.
During 2012, according to Thomson Reuters GFMS, net gold purchases by the world’s central banks increased by 17.4 per cent on the previous year — the highest level in 50 years. We have no idea how much China’s reserve bank is spending on buying gold, for the simple reason that it does not want to tell us. China is on the horns of a dilemma.
On the one hand it wants to build up its gold reserves — from around 1,000 tonnes to 10,000, some say — but on the other hand it wants to avoid triggering a devaluation of the $3.14 trillion it holds in foreign exchange reserves. It wants to reduce its exposure to US dollar-denominated assets, yet at the same time it wants the value of those assets to be protected.
Investors may have fallen out of love with gold, but there is no shortage of counterparties ready to buy up physical gold. Far from damping down demand for gold coins, this year’s price fall has presented a price opportunity for numerous private buyers. Demand for South African Krugerrands and American Eagles has soared, while in India and China the demand for physical gold in the form of jewellery and bars continues to grow.
Indeed, India is importing so much gold (around 80 per cent of its current account deficit) that it has been toying with the idea of raising import duties on it. A third of the world’s annual retail demand comes from India, where gold is often bought during religious festivals, while China, the world’s largest producer, buys all its own production (about 361 tonnes per annum).
It is ten years since the first gold ETF was launched. Today, over 2,000 tonnes of physical gold are held in ETFs, making the ETF market the sixth largest holder of gold. Around 300 tonnes have flowed out of ETFs since the beginning of the year, a shake-out of nervous investors who had been nursing earlier profits. Gold still counts as sound collateral in a world of fiat currencies in economies seemingly hooked on quantitative easing.
Just as with the ‘peak oil’ theory, there is a "peak gold" theory. According to this, declining ore grades and rising production costs mean that annual gold production is unlikely to exceed the current level of 2,700 tonnes, and future demand will easily outstrip supply.
There is a precedent for believing this year’s gold sell-off is a correction rather than the bursting of a bubble. At one point during its upward trajectory in the Seventies, gold lost half its value, only to go on to increase in value by eight times thereafter.
Wherever one looks, and with certain exceptions such as coal, commodity prices seem to be going through a lull rather than an outright decline. One intriguing indicator that the game is not yet up is the fact that pension funds have stepped up their buying of commodities, believing them to be a compelling long-term, strategic play.
The Chinese economy will probably have a softer landing than some have predicted, with growth of around seven to eight per cent sufficient to guarantee rising prices. But the other key factor is the marginal cost of production. When mining companies are no longer able to afford the cost of extraction, supply dwindles and prices creep upwards.