The wreckage caused by China’s great, juddering slowdown continues to spread far beyond the country’s shores. Although most commodities enjoyed a bounce on May 3, after better-than-expected U.S. employment data, the plunge in their prices over the past few months suggests the past decade’s rally is truly broken.
For those of us not in the mining industry, this is actually good news ― one of the best signs yet that the global economy is returning to normal.
China’s voracious demand for every conceivable raw material ― oil, steel, soybeans, gold, to name a few ― once seemed to spell a future of endlessly rising commodity prices and falling living standards in developed nations. This was a Malthusian vision of scarcity: Rising demand from the growing economies of the emerging world would couple with shrinking supplies to drive up the prices of natural resources. Gas prices would never come back down; gold would cost thousands of dollars an ounce.
The response, for many international investors, was to bet big on China. Because it is hard to buy directly into China, many instead bought into the commodities that were being sucked into the gaping maw of the country’s economy: oil from Russia, iron ore from Australia and so on.
The China-commodity connection was born. Financial entrepreneurs started exchange-traded funds, which allowed individual investors to trade commodities, including silver and gold, as if they were stocks.
For the first time, U.S. pension funds started to allocate a share of their holdings to commodities. Even the Federal Reserve got involved, inadvertently, by printing so much money that a good portion of it wound up fueling speculative bets on China and the big emerging markets, often using commodities as a proxy.
Prices went parabolic. From 2000 to 2011, copper prices rose 450 percent, oil prices 365 percent, and gold prices more than 500 percent to a high of more than $1,900 an ounce. There was talk of oil hitting $200 a barrel, and gold reaching $10,000 an ounce. It was a wild time, all predicated on the idea that the rise of China had set off a commodity “supercycle” that could keep prices high indefinitely.
Commodity prices, such as that of gold, tend to rise when faith in the financial system is in decline and usually fall when confidence is high. In this they resemble the politician of whom Winston Churchill once said: “He has all the virtues I dislike and none of the vices I admire.”
High commodity prices enrich a class whose corrupting influence is legend, and whose chief skill is the ability to secure the right political contacts. Meanwhile, high commodity prices, particularly for oil, squeeze the poor and the middle class, and act as a brake on growth in the industrial world. During the 2000s, the U.S. fretted over the rise of corrupt oil tycoons and unstable dictators in nasty petro-states, and rightly so.
That’s why falling commodity prices ― both gold and copper are still down more than 10 percent this year despite the latest bounce ― are good news. The China-commodity connection is breaking. After three straight decades of ultrafast growth, China’s inevitable slowdown has let air out of the bubble: Since the peak in April 2011, the broadest available measure of commodity prices has fallen 16 percent. In recent months, money has started flowing out of exchange-traded funds for most commodities.
The Malthusian specter of rising demand and shrinking supply has been replaced by a new realization that, for most commodities, demand is flat and supply is rising fast. Oil demand in developed nations has been stable since 1995, because high oil prices have inspired conservation efforts in countries such as Japan and the U.S.
Now, as emerging nations begin to embrace energy efficiency as well ― China is working hard on electric cars, for instance, despite continuing to build dozens of coal plants ― global demand might flatten out this decade. The debate over “peak oil” scenarios may shift from the threat of dwindling supply to the threat of peaking demand.
Certainly, the world is no longer terrified of running out of important commodities. High prices have drawn investment to copper mines, aluminum smelters and other basic sources of supply. In the past decade, the amount of capital invested in the energy and materials sector, which includes most nonfarm commodities, has risen 600 percent, compared with an average increase of 200 percent in other sectors.
The much-discussed boom in U.S. shale-gas production is only one result of this spending: Since 2001, China has increased output of industrial metals by striking multiples, from about 140 percent for iron-ore commodities to 775 percent for nickel.
This is part of the normal cycle of the world economy, not a supercycle. Commodity-price booms restrain demand, while attracting money and innovation to increase supply, which leads to a bust. For the last 200 years, the average price of commodities has followed this predictable cycle: one decade up, often sharply, followed by two decades down, with the result that real prices haven’t risen since 1800. There are exceptions to the rule. Some commodities, including oil and copper, have gained somewhat in real terms. But gold has just retained its value. The price today (about $1,500 an ounce) is roughly the same as in 1980, when adjusted for inflation.
If the historical pattern holds, we are now entering a long period of falling commodity prices, which could last two decades. That is good for importers such as the U.S., as was the case in the 1980s and 1990s when commodity prices were falling. The current fall in retail gasoline prices should increase the purchasing power of the American consumer and offset the fiscal drag from the government sequestration cuts.
Meanwhile, the nations that have reveled in the commodity boom of recent years are likely to face a disheartening return to the mundane ordeals of normal life. Buddhist monks have a phrase for it: “After the ecstasy, the laundry.”
By Ruchir Sharma
Ruchir Sharma is the author of “Breakout Nations” and the head of emerging markets and global macro at Morgan Stanley Investment Management. The opinions expressed are his own. ― Ed.
(Bloomberg)
