For the financial markets, 2016 started
quite ignominiously. Stocks worldwide recorded some of the worst first week
openings in history, with the Dow Jones down 6.2% and the S&P 500 down 6%.
In London the FTSE 100 lost 5.3% for the week, and in China circuit breakers
triggered twice to prevent a more 7% fall in the Shanghai Shenzen CSI 300
during the week.
Concomitant with this, emerging markets saw
a sharp devaluation in a range of currencies (including the South African Rand,
of which we are all aware), and the price of crude oil dropped to its lowest in
in more than 10 years. But while it seems like everything started to fall apart
in 2016, the reality is that it started quite a bit earlier. After all, the
stock market’s surge upwards worldwide got halted in their tracks last year
with China’s Black Monday. Oil already had a precipitous decline during last
year that started in 2014, and most commodities had already fallen to new lows
by the end of 2014.
In fact, it seems like a so-called
‘commodity supercycle’ came to an end back in 2014, but a measure of irrational
exuberance kept everyone from fully internalizing this fact, with economies
coasting on hope throughout 2015 for a recovery – a hope that only fell flat on
its face at the start of 2016.
Economic ‘supercycles’ are theories that
the economy behaves similarly to normal business cycles, but over a
significantly longer period, as industries and technologies are discovered,
developed, reaches maturity, and are supplanted. First proposed by Soviet economist
Nikolai Kondratiev back in 1925, with his book “Major Economic Cycles”, this
theory was later expanded by Joseph Schumpeter, who proposed that these
‘supercycles’ be called Kondratiev waves in his honour.
They theorized that longer economic cycles
might reflect the impact of technological innovation and demographics. In terms
of technology, over time one is discovered, then it rapidly starts developing
into an industry, then this industry starts synergising with complementary
industries, until it finally matures. With demographics, it can be observed
that most people’s lives follow a predictable economic pattern, initially
debt-fuelled purchases of capital, starting with schooling, a car, then a
house, while income is low, and then a gradual reduction of debt while income
increases and savings increase as well, until retirement, when savings is
maximized, income drops, and the savings is gradually depleted during
retirement.
It makes intuitive sense that the overall
economy would in a way sync up with industrial development and changes in the
demographic make-up of its participants. But given the long-term nature of
these cycles, we lack the necessary recorded history to show its existence thus
far. In the case of commodities, however, the capital investment and output
cycle are long enough that a similar set of circumstances arise in the industry
naturally.
When China joined the WTO in 2003, its
economy started to heat up. China started to develop its infrastructure, and
had a huge need for raw materials. But for the twenty years prior, commodities
were trading at just below all-time lows. China’s sudden need for more capacity
(an increase in demand), did what traditional economics predicts – an increase
in demand with supply constant raise the price. Commodity prices continued to
‘boom’ during the 2000’s, and these high prices spurred investment in mining
and prospecting, with loans etc. taken out to develop now profitable ventures.
But mining operations take a while to develop and start up, and by 2010 the
first of these new mines started supplying. With an increase in supply to match
the increased demand, prices stabilised. But what goes up… ?
During 2014, with 10 years of
infrastructure development done, China started to slow down. All the
low-hanging fruit was plucked, and infrastructure costs were skyrocketing.
Curtailing spending was natural for its development. But for mines expecting
the demand to hold up, this came as a surprise. Because as traditional
economics predicts, with an increase in supply and a decrease in demand, comes
sharp fall in the price.
Most producers kept producing, sometimes
lending cash to keep operations going in anticipation of a price correction
upwards that never came. Oil, at first, seemed resistant, because conflict in the
Middle-East kept uncertainty high. But as it became clear that oil supply lines
were not under threat, oil, too, collapsed.
Eventually, though, even hope runs out.
With signs that China is definitely slowing down, and no indication of demand
increases elsewhere, even the blind could see commodities are oversupplied, and
will remain so until a new ‘source’ of demand can be found. Mining and oil
companies are shelving projects, and retrenching workers, and those effects
reverberate throughout the global economy. And so the cycle goes. While it was
in upswing, it seemed that the good times would never end. With the downswing,
it now seems there’s no end in sight to low commodity prices. But what goes
down… ?
But just as everything that goes up must
come down, so too all downward trends eventually revert to the mean. Closures
and bankruptcies, hard as they are, will reduce supply and raise prices, or our
economies will grow to utilize them. Perhaps, with input costs of raw materials
this low, now is the time for all companies to consider investing in cheap
infrastructure – after all, when the recovery comes, steel and oil will be more
expensive. Or maybe a new ‘infrastructure growth’ economic tiger will emerge on
the world stage… Iran has just re-joined the world economy after years of
isolation, and needs to upgrade infrastructure and more. How ironic would it be
if the international pariah turned out to be the saviour the world economy
needs right now?
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