Goldman Sachs thinks a new commodity supercycle could be underway. We think they might be right.
If they are in fact right — which is easily possible — base metals like copper, along with other commodity staples widely used in construction, vehicles, and home appliances, could be looking at price gains that stretch out over a decade, or even multiple decades.
A recent Goldman Sachs research report, published in November 2020, laid out the case for a “structural bull market” in commodities, with “similar structural forces to those which drove commodities in the 2000s.”
To understand Goldman’s argument, we need to dial back the clock 15 years or so.
In the mid-2000s, China looked ascendant, and a great deal of excitement surrounded the BRIC countries — Brazil, Russia, India, and China.
Emerging markets were center stage back then, so much so that many believed “The Emerging Markets Century” was at hand.
In 2007, a book of the same name — The Emerging Markets Century — was published by Antoine van Agtmael, the policy consultant who originally coined “Emerging Markets” as an investing term.
With China driving demand trends, and other fast-growing emerging markets seeming to follow suit, commodities were believed to be in a BRIC-driven supercycle.
Institutional demand for commodities as an investment class was also high in the mid-2000s — the logic being that, if commodity prices were going to rise for decades, institutional portfolios should have exposure to them.
This logic contributed to a five-fold rise in copper over the course of the 2000s, and the West Texas Intermediate crude oil price running up to $133 per barrel in 2008.
But the commodity supercycle was stopped cold by the global financial crisis of 2008, and so were emerging market equities, which took more than a decade to regain their late-2007 highs.
(Ironically, The Emerging Markets Century was published just in time for a ten-year struggle.)
In the initial supercycle of the 2000s, the BRIC countries — and other emerging markets, too — were expected to see a virtuous circle of rising consumer demand, bullish investor sentiment, and robust local growth.
Picture billions of new capitalists clamoring for washing machines, air conditioners, and cars as they joined the ranks of the global middle class, even as cities were built out with 21st century infrastructure.
The emerging market dream stalled out, though, and the years that followed the financial crisis were a total bust for commodities, with bellwether commodity indexes and ETFs losing more than half their value in the 2010s.
Now, though, the whole world is in stimulus mode, the global economy is anticipating a vaccine-powered recovery, and the U.S. dollar could be headed into a multi-year downtrend.
All of that favors a new commodity supercycle getting underway, and possibly lasting longer this time.
The basic idea behind a commodity supercycle is that global demand for commodities shifts upward in a fundamental, structural type of way, with the elevated demand trend so strong that it takes decades for production to catch up.
There are five potential drivers for seeing that kind of structural demand shift in the years to come: Green energy initiatives; FDR-style infrastructure projects; reworked home spaces in a post-pandemic world; urban center renewal; and emerging market growth. To briefly cover each:
- Green energy initiatives, along the lines of ramping up renewable energy sources, phasing out internal combustion engines, retro-fitting buildings for energy efficiency, and moving toward net-zero carbon emissions, could require trillions of dollars of spending over the next few decades — much of it oriented toward green energy projects that will utilize base metals and other commodity staples.
- FDR-style infrastructure projects, of the kind President Franklin Roosevelt used to create jobs in the Great Depression, could be popular all over the world in the coming decades, especially given that rich, industrial countries like the U.S. and Germany are in dire need of long-term infrastructure repairs. An overhaul of roads, bridges, power stations, transportation networks, and more could be a powerful source of demand for raw materials.
- For knowledge workers and those whose jobs enable it, the transition to work from home (WFH) is not going away, with millions of workers likely to adopt WFH conditions either permanently or part-time (one or two days per week) after the pandemic. This shift is spurring a deep rethink of home-based needs, with an emphasis on more square footage (to make room for that home office), more home-based amenities, more green appliances, and so on. This means lots of construction and plenty of new gadgets, bullish for copper and other raw materials.
- As cities see a transition away from office buildings and corporate real estate, an opportunity will arise to transform urban centers and make them more livable. That means more outdoor dining, more green buildings, more mixed-use residential space, more reclamation of parking spaces (with fewer cars coming in) — and lots of construction to make it happen, once again driving a structural demand for raw materials.
- Emerging markets were largely ignored and left in the cold for the decade following the global financial crisis. Investors’ attention was instead fixated on big tech and opportunities within the United States. Now, though, the U.S. dollar may have registered a long-term peak, and emerging-market assets look highly attractive relative to overvalued U.S. equities — especially if a structural bull market in commodities is increasing their revenues and profits, creating a virtuous cycle of more direct investment and more local growth. The build-out of domestic consumer demand — those “three billion new capitalists” making their way toward middle-class status — could then further drive raw materials demand.
The other two factors favoring a commodity supercycle outlook are the twilight of the U.S. dollar as the world’s reserve currency — it won’t crash or go to zero, but it seems hardly possible the dollar will continue to hold a 60% market share of central bank reserves — and the incredibly overvalued nature of U.S. equity names, particularly technology names.
If emerging markets can catch the twin tailwinds of a weakening dollar and rising commodity prices — both of which act like stimulus for their commodity-oriented economies — we could see a virtuous circle in which more demand for commodities translates into more demand for emerging-market assets, which in turn causes the dollar to weaken further as investor capital flows out of the U.S., with the weaker dollar then boosting commodities further and strengthening the cycle even more.