On a day when gold plummeted and oil dropped right alongside it, Citi Research was throwing dirt on the grave of the commodity super cycle.
The then-Goldman Sachs Commodity Index hit its bottom in early 1999 (it’s now the Standard & Poor’s GSCI), and the talk of a new commodity super cycle began soon after that. You’d hear frequently that the super cycle was going to last 15 years, or maybe 20. So it’s about 14 years old, and Citi Research’s Ed Morse, in a report released Friday, says it’s breathing its last. (Full disclosure: Standard & Poor’s, like Platts, are both owned by McGraw-Hill Financial.)
“The second quarter should provide another affirmation that the so-called commodity supercycle has finally ended and should usher in the first ‘normal’ year in over a decade in which, broadly, commodity prices end the year lower than when the year started,” Morse said in his report. The super cycle’s end has been building for several years, Morse said, noting a “Supercyle Funeral” that began in 2011. This year would be the “afterparty.”
The report clearly wasn’t written just on the back of the fall in gold prices Friday; they were down more than $85 on the CME to a settlement less than $1,500 after almost reaching $1,800 last fall. Instead, it’s a broader macro outlook that happened to be published on a day of steep price declines that put an exclamation point on its findings.
“For the next few years, each commodity looks more likely to be sitting on its individual supply/demand fundamentals than on more general factors affecting all of them,” Morse wrote in the report. “This means that as either their separate long-term and short-term cyclical logistics take over, for some prices will rise while for others they will decline, and investors across commodities will be able to take advantage of alpha return strategies focusing on long versus short positions, other relative value relations across the commodity space as well as across time spreads, changes in momentum and volatility.”
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Equity markets and commodity markets have been moving for years with high correlation, but that’s a trend that clearly has broken down. So somebody who wants to invest in commodities in general can’t just ride a rising commodity wave, linked to a stronger equity market, to solid returns.
Those strong returns in commodity markets, the report said, were fueled by tight supply conditions. But that’s changing. “In the decade ahead, we believe investors will need to gain a greater understanding of demand conditions,” the report said. “Shifts in underlying investment patterns in China and other emerging markets are a critical source of change for aggregate consumption as China and other (emerging nation) growth shifts from more commodity-intensive fixed asset investments and industrial production growth to household-based and service sector growth. But policies are likely to move in the same direction, as subsidies for food and fuel come under fiscal pressures and as environmental policies play a role.”
And oil is going to be a part in that.
What Morse called a “once-unimaginable” drop in oil demand is now “an attainable global reality,” noting the growth of electric vehicles and tighter US fuel efficiency standards. But that’s just a start.
“The real challenge to oil’s dominance of the transportation fuel market comes from natural gas, and the challenge is not only in the US but in global markets,” the report said. “A recent Citi study has shown that up to 20-million b/d of petroleum product demand could be challenged by natural gas in a decade, and about half of that is LNG substituting for diesel demand in truck and rail use in the OECD and of bunker fuel in global markets.”