The commodity super-cycle: Demand intensity buoying prices

THE commodity super-cycle, in which commodity prices reach ever-higher highs and fall only to higher lows, is not over.

Despite the euphoria around shale gas — indeed, despite weak global growth — commodity prices have risen as much as 150% in the aftermath of the financial crisis. In the medium term, this trend will continue to pose an inflation risk and undermine living standards worldwide.

For starters, there is the convergence argument. As China grows, its size, wealth, and urbanisation will continue to stoke demand for energy, grains, minerals, and other resources.

For example, the US consumes more than nine times as much oil as China on a per capita basis. As more of China’s population converges to Western standards of consumption, demand for commodities — and their prices — will remain on an upward trajectory. Of course, not all commodities are equal. For example, although the case for copper seems straightforward, given that it is a key input for wiring, electronics, and indoor plumbing, a strong bid for iron is not as obvious, given the Chinese infrastructure boom that already has occurred in the past two decades.

Worst-case estimates have China’s real GDP growing at around 7% per year over the next decade. Meanwhile, the supply of most commodities is forecast to grow by no more than 2% annually. Unless China’s commodity intensity, defined as the amount of a commodity consumed to generate a unit of output, falls dramatically, its demand for commodities will be greater this year than it was last year.

As long as China’s commodity demand grows at a higher rate than global supply, prices will rise. And the rapid economic growth that China’s leaders must sustain in order to lift enormous numbers of people out of poverty places a floor under global food, energy, and mineral prices.

Intensity of use has fallen for some commodities, such as gold and nuclear energy; but for others, such as aluminum and coal, it has risen since 2000 or, as is the case for copper and oil, declines have slowed markedly or stalled at high levels.

As the composition of China’s economy continues to shift from investment to consumption, demand for commodity-intensive durables — cars, mobile phones, plumbing, computers, and televisions — will rise. There is also the issue of the so-called reserve price. It places a cap on how high commodity prices will go, as it is the price at which demand destruction occurs. For many commodities, such as oil, the reserve price is higher in emerging countries than in developed economies.

One explanation for the difference is accelerating wage growth across developing regions, which is raising commodity demand, whereas stagnating wages in developed markets are causing the reserve price to decline. By implication, if nothing else, global energy, food, and mineral prices will continue to be buoyed by seemingly insatiable emerging-market demand, which commands much higher reserve prices.

Ultimately, emerging economies’ absolute size and rate of growth both matter in charting commodity demand and the future trajectory of global commodity prices, with per capita income clearly linked to consumers’ wealth.

Around the world, governments are taking greater control of resources and imposing policies that hamper global production and ultimately force prices higher. Such price increases can prove particularly inflationary in countries that import commodities. And they can be disastrous to exporting economies, which risk rapid currency appreciation and thus a loss of competitiveness.

There is a perennial temptation to focus on the short-term, tactical drivers of commodity-price movements, at the expense of giving longer-term, structural factors their due. While short-term factors — political instability, weather-related disruptions, and speculative activity — are important determinants of prices, they tell only part of the story.

The fundamentals of supply and demand remain the key factors in driving the direction of commodity prices and determining whether the commodity super-cycle will persist. In practical terms, this means oil prices, for example, are more likely to hover near $120 (€92) per barrel over the next decade, rather than $50; and we are unlikely to see a $20 barrel again.

* Dambisa Moyo is author of Winner Take All: China’s Race for Resources and What it Means for the World