The "Commodities" Super Cycle

The Buzz around the Commodities Super Cycle

By definition, a super cycle is a prolonged (decade or more) trend rise in real commodity prices. A super cycle is driven by urbanisation and industrialisation of a major economy.

Many economists believe there have been only two super cycles in the last 150 years. The first was driven by the economic growth in the US from the late 1800s to early 1900s. The next super cycle, from 1945 to 1975, was prompted by the post-war reconstruction of Europe and then by the huge economic expansion of Japan.

Previous Under-Investment

The severity of the last crash in commodity prices meant there has been a 10 to 15-year period of under-investing in production, exploration and infrastructure. The existing operations are therefore running at near or full capacity. The poor mining infrastructure means that companies have been scrambling to remedy these shortages, however, this takes time, manpower and funds. The lead-time in commodity production can be years. It's no secret that commodity prices has risen dramatically in the last the few years, with China being the major force behind the demand, accounting for more than 20% of the growth in global demand.

However, are we close to a structural peak or are there structural changes in place? In short, can the market sustain continued high commodity prices and thus becoming a true super cycle? If the resource sector is currently enjoying the buoyancy in high commodity prices provided by a "super cycle", then the rapidly expanding Chinese economy needs to maintain its position as a major growing force in the world economy. That is, the tight supply/demand conditions for resources must be maintained.

China
China has grown from 7-10% of world demand for the main base metals (copper, aluminium, zinc, nickel, steel and iron ore) in 1993 to 20-25% of world demand in 2003. China now has new roads, new hospitals, new hotels, new offices, new houses, new shopping malls and new factories, however, even with all of this infrastructure in place, optimistic estimates say that by 2010 China will account for more than 30% of global demand.

Moreover, it is not only China that has driven commodities demand; the developed countries like Japan, Germany, South Korea and the United States are also contributing to demand for basic resources in competition with the growing economies of Russia, India and Brazil.

India
One underestimated contributor to future demand within a super cycle will be India. With a GDP growth of 7%, the government of India is committed to lift a third of its 1.1 billion people over the poverty line. This will mean that an estimated 83 million new homes will be needed over the next 20 years - that is 4 million per year, and that does not even take into account population growth which could double that number.

If we are indeed in the middle of a super cycle, the rich resource-based Australian economy is well positioned to take advantage for a few more years, albeit with rocky periods along the way.