Can there be a commodity supercycle if China’s not pedaling?

The concept of commodity supercycles has had a difficult history. It has its roots in the work of Nikolai Kondratiev in the early 1920s. He fell out in turn with Trotsky, Gosplan and Stalin, was imprisoned and then executed some years later. And economists today still disagree over whether the “long waves” he identified in commodity prices and other macroeconomic variables even exist.

But interest in commodity supercycles is undergoing a cyclical boom and the question of whether a new one is getting underway has been a central theme of this week’s FT Global Commodities Summit. Our commodities team has written a great deal about the topic (the links are to analysis behind our paywall and for clients only — if you’re not one already and would like a free trial click here). So we were pleased to have an opportunity to test our (sceptical) views at an FT-moderated debate against those of two of the leading proponents of the supercycle thesis, Sir Mick Davis (formerly Xstrata, now Vision Blue) and Jeff Currie (Goldman Sachs). We had fellow sceptic Dr Jumana Saleheen of CRU on our side.

The supercycle thesis is that a step change is underway in demand for commodity-intensive products that is similar to the surge in Chinese demand that fuelled the long run-up in commodity prices after it entered the WTO in 2001. The driver this time is some combination of green spending (both consumer spending, such as on electric vehicles, and related infrastructure like charging points), broader infrastructure spending (all those calls to Build Back Better, and a more capacious understanding of fiscal constraints), and efforts to reduce inequality, which some believe will support much stronger spending by poorer households.

The weakest form of the argument it seems to me is that these factors are behind the rise in commodity prices over the past year. It’s fairly clear that the surge in demand that has lifted prices is the result of two entirely separate developments that would not have happened without the pandemic and won’t long outlast it. (I won’t get into disruption on the supply side here, but that has been a factor too.)

First is a boom in global spending on commodity-intensive consumer durables, as households around the world have adapted to restrictions on their day-to-day lives. Equipment for working from home, for home renovation and for exercise have all been in short supply. This spending has been helped by the fact that, unusually in a global downturn, household incomes have held up, and in the US got a big additional boost this year from stimulus cheques. Taiwan recently reported orders for semiconductors 74% higher than pre-pandemic. China’s exports of consumer durables earlier this year were more than 50% above the pre-pandemic level. Such abrupt increases can’t be squared with the long-run drivers of the supercycle view.

The second leg of support for commodity prices over the past 12 months has been the old-fashioned infrastructure-focused stimulus pursued in China. We have a proxy gauge of construction activity for China that is currently 15% higher in real terms than it was at the end of 2019. This element of the rebound should be familiar: it was China’s investment-heavy stimulus that drove the even bigger rebound in global commodity prices in 2009, which many at the time argued would be sustained by the lasting strength of China’s urbanization-fuelled investment. Instead, industrial metals prices peaked in 2011 and by the start of 2020 had fallen by half. Policy support has this year already been withdrawn in China. There’s always a lag before that is reflected in activity on the ground. But a slowdown will be increasingly evident in our view over the next few months just as we saw after the post-financial crisis rebound.

Nonetheless, even if it doesn’t explain the past 12 months, the supercycle thesis could hold up over the next few years.  This is where the more interesting divergence between the supercyclists and sceptics emerged during the FT debate.

Both sides seem to agree that China’s commodity demand will weaken over the coming decade. And we agree particularly with the green economy element of the argument that there are significant structural shifts underway in commodity demand. Electric vehicles for example are far more copper intensive than regular ones. The world’s demand for batteries is taking off, lifting demand for cobalt and nickel as it does. 

Where we differ is over which of these two developments will determine what happens to prices in the next few years. China now accounts for more than half of global demand for the main industrial metals. If we look at a pie chart of sources of demand, those represented by new economy uses are still tiny slivers. Electric vehicles account for less than 2% of global copper demand. China’s infrastructure and property sectors account for about a third. Some 8% of the world’s nickel is today used in batteries while 70% goes into stainless steel.

The argument is sometimes made – and was during the FT debate – that China’s impact on commodity prices in the 2000s shows that rapid growth even from a low starting point can very quickly have a transformative impact on demand. But that’s a misunderstanding. China was already a very big consumer of industrial commodities before its take-off. In 2000, China consumed more steel and zinc than any other country and was second only to the US in its consumption of copper and aluminium. From that starting point it’s no surprise that an unanticipated surge to double-digit GDP growth had a large impact.  The share of commodity demand represented by batteries and electric vehicles today is an order of magnitude smaller than China’s share was in 2000. As a result, even very rapid growth in these new areas could easily be offset at least for the next few years by any substantial weakening of industrial metals demand in China.

And there are good reasons to expect substantial weakening. First, a transition to more environmentally-friendly growth in China will create a large headwind to its industrial sector. As elsewhere, investment in green infrastructure will boost industrial metals demand. But Xi Jinping has pledged to cap China’s carbon emissions by 2030. China will only achieve that goal by restraining investment in other metals-intensive areas including property and infrastructure. So while, for example, aluminium demand will get a boost from a further expansion of China’s electric vehicle fleet, it will also be dented by a slowdown in the property sector, where it is also used extensively.

Second, the broader trajectory of China’s economy is towards slower growth. We estimate that trend growth halved in the 2010s, and we expect it halve again in the 2020s as Xi Jinping’s push to entrench the Party’s role leads to a further slowdown in productivity growth. The demographics are getting worse too. And within that slowdown, growth is likely to be getting less investment-intensive too, which will compound the impact on demand for many commodities.

Acknowledging this doesn’t mean we have to be bearish across the board on the outlook for metals. For example, China’s Five-Year Plan confirms that the leadership expects – and wants – construction of infrastructure and property to slow, but investment in “Strategic Emerging Industries” (electric vehicles among them) to accelerate. Some commodities could still perform well in that environment against a backdrop of weakness elsewhere: it will pay to focus on the demand outlook for specific commodities. But in these circumstances China will still be the key factor on the demand side of the commodity equation. And with broad headwinds from China, it is hard to see how a supercycle in industrial metals can emerge.