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Is the commodity supercycle stalling?

Slower growth out of China is taking steam out of runaway commodity prices.
In the current cycle, most producers are delivering massive dividends to shareholders. Image: AdobeStock

The post-Covid economic rebound has hit a speed wobble in the form of slowing Chinese growth.

The World Bank estimates Chinese economic growth to slow to 5.4% next year, from 8.5% in 2021. That expected slowdown has started taking some of the steam out of commodity prices such as rhodium, palladium, oil and copper.

China’s remarkable recovery from the post-Covid crash in March 2020 rescued the global economy, but the looming slowdown will drag the rest of the world with it, particularly commodity-dependent countries like SA.

This could stall one of the longest commodity supercycles in decades as China transitions to slower, more sustainable growth based on domestic consumption rather than exports and investment.

Listen: Deryk Janse van Rensburg of Anchor Capital discusses commodity prices on MoneywebNOW

Decades-long supercycle

“This has been the biggest commodity supercycle in history, and it’s been going on for the better part of two decades, but I think it is coming to end,” says Peter Major, mining director at Mergence Corporate Solutions.

“Gravity always wins in the end, and I see commodity prices reverting to their mean before their likely over-shooting to the downside. The current cycle commenced in 2003, and is the longest cycle we have seen since at least the 1860s.”

It’s been a record-breaking year for SA miners like Kumba Iron Ore, Royal Bafokeng Platinum and Anglo Platinum, and the good times may continue a while longer with miners like Exxaro expecting its half-yearly earnings to double, in large part because of its investment in iron ore mining at Sishen in the Northern Cape.

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What’s different about this leg of the commodity cycle is the spending and investment discipline exercised by miners, says Major.

“In the previous cycles of this millennium, miners spent about $2.5 trillion in projects that were almost all written down to zero. This time around they have been far more conservative, investing and expanding much less and in smaller projects with much quicker payback periods and also returning huge cash in the form of dividends to shareholders.”

Supply and demand

Vaughan Henkel, head of equities research at PSG Wealth, points out that higher commodity prices attract additional production, which in turn levels out any supply-demand imbalance. “What this means is that in time, commodity prices will moderate. It’s pleasing to note that during this current cycle, most producers are delivering massive dividends – including special dividends – to shareholders.

“During previous cycles, cash went to capex and mergers and acquisitions, and that didn’t always work out well for shareholders.”

China’s economic outlook is crucial to commodity markets, as the following table shows. Outbreaks of the Covid Delta variant in China have prompted a quick and draconian lockdown by authorities, and this is likely to be followed with stimulus to ensure no economy surprises to the downside.

Despite the growing headwinds in China, Henkel says oil is an interesting case “because capital will be constrained due to environmental concerns, but that may result in higher prices due to a limited supply response, as we have seen”.

“Oil prices may remain elevated as a result.”

Source: Morgan Stanley Research

Blowing off steam

Recent price activity on key commodities shows rhodium dropping nearly a quarter from its May high of $29 000, while palladium is down 12% since April.

Having rallied from a low of $20 a barrel in March 2020 to $74 a barrel, oil also seems to be cycling back some of the recent gains.

The preferred proxy for industrial demand is copper, which rallied from $47 a tonne to $107/t before easing back to $94/t.

The chart below shows coal surging towards levels last see a decade ago. Looking at this chart, it is hard to argue that the supercycle is over, though coal is somewhat of a unique story: financiers have bolted from the sector, making it difficult to get new projects off the ground.

In this sense, the green lobby is a victim of its own success, having chased financiers from dirty fossil fuels, prompting a spike in demand.

Supply has been constrained by heavy rains in Indonesia and Australia, a mine closure in Colombia, a Chinese ban on Australian coal, and strong demand from Asia in the midst of a sweltering summer.

Alternatives to coal are simply not available in the quantities required, sparking intense price competition on the supplies that are available.

SA coal export prices (USD/tonne)

Source: IndexMundi

David Llewellyn-Smith of Nucleus Capital, writing at Livewire, says Opec (Organisation of the Petroleum Exporting Countries) will lift output by 400 million barrels a day (mb/d), while Iran will likely add another 2mb/d in the near future, all of which will land on a global economy that is slowing. US shale oil producers are also taking advantage of recent price rises to ramp up rigs.

Chinese demand has pumped up iron ore prices to their highest levels in history, as the following chart shows. The Global Times of China reports that the Chinese government has taken measures to curtail soaring iron ore prices by, among other things, looking at ways to diversify away from iron ore.

This was reflected in the Kumba Iron Ore results published in the last few weeks, and has also been crucial to SA-China trade.

“In the first six months of this year, trade between China and South Africa soared 70.4% in US dollar terms, followed by trade between China and India with a growth of 62.7%, both outperforming the former’s trade performance with other major trading partners. The iron ore trade is probably a big contribution behind such spectacular trade performance,” says The Global Times of China.

Iron ore price (USD/tonne)

Source: IndexMundi

Anthony de la Cour, investment analyst with Matrix Fund Managers, says iron ore is the most at risk of a correction, as Chinese demand normalises from a period of excessive stimulus and supply comes back online.

“This implies it should trend towards marginal cost of production which is approximately $80/t currently, although it is likely that this will take a number of years. I certainly do not see the likelihood of such low pricing in the near term at all. Likewise, whereas thermal coal is also trading above marginal cost, the barriers to more production are structural and will also take some time to correct. Our expectation is for this to be a two-to-three-year process.

“Finally, we are very cautious on rhodium. Our view is that the heady recent prices are wholly unsustainable but forecasting timing on this is difficult. Whereas as we see more support for platinum and palladium over the medium term, the large contribution of rhodium to the current PGM basket price leaves us currently very cautious about the sector.

“With respect to commodities in general, our view is that we have likely seen peak pricing for now, but capital discipline of mining producers in this cycle leaves us broadly constructive once the recent covid induced demand-supply windfalls have normalised.”

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What can go wrong?

If there is a significant sustained decline in commodity prices that could be more of an economic blow for SA than COVID and the riots combined. Tax revenues would come under pressure, the rand might weaken due to reduced commodity export values (and rising US interest rates) and inflation would pick up. A really nasty storm that the state is not in a strong financial position to weather.

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