The shares of mining companies are booming on the back of bouyant commodity prices. How did the super-cycle turn into a rollercoaster?
Remember the commodity super-cycle? The theory, popularised investor and author Jim Rogers, was that commodity prices followed long bull and bear phases dubbed super-cycles. The latest bull phase started in 1999, and was apparently set to run for 17 years.
The super-cycle concept really gained currency in 2006 and 2007 as a justification for the steep climb in the value of mining companies.
Commodity prices had surged as predicted, and mining giants like BHP Billiton (LSE: BLT) and Rio Tinto (LSE: RIO) threw off cash like confetti. They were also seemingly cheap -- often on single digit P/Es.
But to believe the big miners remained good investments, you had to believe the earnings side of the P/E equation would stay near record highs. Believing that unusual peaks will continue in investment terms usually means signing up to some grand new theory, and the super-cycle concept fitted the bill.
Unfortunately, like the dotcom-based New Economy and the notion that U.S. house prices could never fall, the super-cycle theory proved bunkum.
From super-cycle to super-slump
Commodity prices collapsed in late 2008, falling to six-year lows by December. According to Barclays Capital, the 60% drop in the price of copper, zinc and lead exceeded the equivalent slump in the Great Depression.
Where commodity prices led, miners followed:
|Company||2008 High||Subsequent Low||Decline|
|Xstrata (LSE: XTA)||2,515p||289p||89%|
|Rio Tinto (LSE: RIO)||7,167p||995p||86%|
|Lonmin (LSE: LMI)||3,700p||536.5p||86%|
|Anglo American (LSE:AAL)||3,683p||906p||75%|
|BHP Billiton (LSE: BLT)||2,005p||731.5p||64%|
As investors pulled money out of the equity markets, some said we were heading for a second Great Depression -- assuming it wasn't worse. Previously cocksure companies like Xstrata and Rio Tinto announced rights issues or raised money from large investors to batten down their debt-laden balance sheets against the storm.
Yet as ever, what in hindsight was the point of maximum pessimism proved a great buying opportunity. Earlier this week commodity prices hit a seven-month high, and the S&P GSCI spot commodities index is up 30% on the year.
Mining companies have bounced back, too:
The decline and subsequent rise of mining shares is extraordinary. But don't concentrate on the extremes -- only stock market historians buy at the bottom and sell at the top.
The point is that far from the steady march upwards promised by the more naive interpretations of the super-cycle theory, resources and the companies that pursue them have risen and fallen with the economic outlook.
Was the super-cycle theory wrong?
Proponents of the super-cycle theory, buoyed by recent gains, argue it's still on track. Nobody said there wouldn't be speed bumps along the way. I'd say a bullish theory that brushes over 80% declines isn't of much use in practical terms when investing.
Other super-cyclists point to the once-a-century credit crunch, arguing that the near-collapse of the financial system couldn't be anticipated. As normal conditions have returned, the underpinnings of the bull market have reasserted themselves.
It's true the super-cycle theory wasn't just based on the right-until-proven-wrong dynamics of a typical stock market bubble. The two billion consumers of China and India that joined the global market in the past 20 years really do represent a vast new demand on the world's resources. And even if you believe talk of decade-spanning super-cycles belongs with the horoscopes rather than in the financial pages, there's no doubt the commodity business is inherently cyclical.
Underinvestment when prices are low and the sheer work, time and infrastructure required to dig more stuff up or chop it down means it takes a while for supply to meet rising demand, causing prices to spike up. In turn, the subsequent extra supply tends to overshoot, causing prices to fall and making marginal suppliers uneconomic. Boom and bust is baked into the business model.
The only way was up
Personally, I think the commodity markets have simply been trying to anticipate the outlook for the global economy, just as they have always done.
Not only did commodity prices fall as demand slowed with the US and elsewhere entering recession -- when we faced total financial meltdown, traders presumed more flatscreen TVs, supertankers and Arabica coffee wouldn't top anyone's priority list (unfortunately baked beans, the classic snack of the post-apocalypse, isn't a tradeable commodity).
Now global economic growth is expected to pick up and deflation fear is morphing into inflation phobia, commodity prices are strengthening.
The weakening dollar doesn't hurt. Commodities are priced in dollars, so a lower dollar means you need more greenbacks to buy your barrel of oil or skip load of iron ore, causing their price to go up.
Riding with the super-cyclists
I bought shares in a couple of the more solid mining giants last year on the basis of their dividend yields.
But beyond that, volatility in the commodity markets makes it hard to be sure of miners' future earnings and so their share price in the short-term.
If put on the spot, I'd guess the bargain prices for miners have probably gone, but a resumption in global growth should make them decent investments over 5-10 years. The Chinese and Indians are still building shopping malls and buying mobile phones.
Set against that, there have been new nations joining the global economy for centuries, and over the long-term commodity prices have actually declined relative to output and in real-terms.
So beware a cheery consensus that prices can only double or triple -- it'll probably presage the next leg down on the commodity rollercoaster.
More from Owain Bennallack:
> Disclosure: Owain owns shares in BHP Billiton and Anglo American.