Commodities - Is it the end of the supercycle?

The commodities market have witnessed a massive tumble over the past few months as the readjustment to expectations of lower global growth shift to overdrive. Though the fall has been sharp across the entire complex, two commodities which are considered as bellwethers due to their performance being tied to economic activity - Crude oil and Copper have witnessed the sharpest falls. From the highs reached earlier during the year, Crude oil prices are down about 56% while Copper prices are down about 57% aS on October 24th. What an irony it has turned out to be - just 6 months ago what seemed like a supercycle has now been labelled a bubble. Has the commodities story ended?


Being a commodities analyst myself, i closely follow research reports from several analysts including John Reade - a noted Precious Metals Analyst and Head of Commodities strategy at UBS Investment Bank. In one of his daily roundups John had mentioned of an upward revision in Copper price targets by Alan Heap, Head of Commodities at Citi and said this forecast comes from a bloke who had coined the term "supercycle". In my view, the commodities supercycle has received a jolt - no question about it, however it is wrong to write off commodities especially if the time horizon of 3-5 years is considered.


Presently global markets have been in a tailspin, as the largest economies of the world, the US and Europe, are in a synchronized slowdown. I would attribute expectations of falling demand as the pivotal factor for lower commodities prices, even as the supply side has remained static. But then if demand is likely to be lower, who cares what the supply side is doing? An example which typifies the massive sentimental swing in the commodities market is Crude oil, which rallied even as OPEC increased production in September 2007 as it was thought the increase in production would be insufficient to meet demand. In September 2008, OPEC actually asked members to reduce overproduction from their quotas and guess what....the markets fell!!


Clearly it is economic activity which is the main driver for commodity prices. The weakness in commodity prices could continue until some semblance of sanity or normality returns to the markets - i know these words are the exact antithesis of what has been transpiring in the markets off late. Another significant factor contributing towards weakness in commodities has been a stronger Dollar. In my view, clearly the US Dollar has emerged as a safe haven in these tumultous times, notwithstanding the traditional belief of Gold being a safe haven asset. The sharp falls witnessed in Gold prices from time to time has led me to believe safe haven buying interest is not always a reliable price driver. Its difficult to pinpoint the length of time for which the rally in the US Dollar will continue, however the greenback clearly stands to benefit further as other central banks - most notably the European Central Bank and the Bank of England have a significant distance to go in terms of easing interest rates.


Thus, taking a view from where things stand presently the road to a recovery of economic activity is bound to be a long and painful one. But as economic activity revives and liquidity in global markets is restored we should see commodities bouncing back strongly, a significant factor being strong demand from the Emerging markets. A factor which could increase in importance as recessionary concerns recede, is supply side adjusments. Producers of several commodities are likely to reduce production as an adjustment for falling prices, examples being Zinc and Nickel, this should be supportive for prices especially in a scenario when demand stages a comeback. When is this likely to happen - well it looks like it could be a while coming, may be sometime in 2010. The wheels of the supercycle seem to lack traction presently, though i believe a sustainable recovery is likely to occur sometime over the next 12-18 months.