The concept of a commodity super-cycle seems to have gained a large investor following, but some argue against it.
Have you heard of the commodity super-cycle theory? I'll bet you have, because over the last few years it seems to have become a regular feature of everyday investment journalism. Many investors seem to accept the theory as a 'given' but there is an attractive counter argument out there.
The next big thing
The super-cycle theory holds that commodity prices often rise in long-term cycles with the upward moves lasting 17 years or longer. The current upward move is believed to be driven by demand for raw materials from rapidly industrialising countries like China and India.
Commodity bulls like Jim Rogers believe that commodity prices have a long way to go from here and many investors, who always seem to be looking for the next big thing, have taken the theory to heart.
Just a normal cycle
Although recognizing that commodity prices have risen a lot already in the last few years, some believe this may be explained by the fact that prices had been very depressed for around twenty years previously. This meant that investment in production was not forthcoming in an environment of depressed commodity prices. Therefore, any increase in demand would initially cause prices to rise before increased production could catch up. Investor speculation would only serve to exaggerate the effect.
However, all this does not necessarily presage a super cycle. Higher prices in themselves encourage the supply and demand equation to rebalance as investment in production becomes more attractive and raw material usage becomes less attractive. Furthermore, as the downward leg of the previous commodity bear market was longer than historically normal, the recent rises may be due to a longer upward leg, which is necessary to restore equilibrium.
Non super-cyclers accommodate rising prices in their thinking, but believe that it takes a mental leap beyond what may be reasonable to believe that prices will go on and on rising for around 17 years in total.
Watch out for speculation
I don't know what will happen next of course, but observing that investor speculation tends to drive markets ahead of events and looking at the big price rises of the last few years, I am inclined to be cautious. There is a fair chance that much of the fundamental supply and demand imbalance may already be in the price. I would not bet the farm on commodities now.
The fact that every body knows about the opportunities in commodities may mean that it is too late to catch the big rises, which may already have occurred. However, there is a place for well-managed commodity companies as part of a normally diversified portfolio, and with this in mind, I will be comparing the big mining companies on the London Stock exchange in my next article.
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