Commodity prices tend to go through extended periods of boom and bust, known as supercycles.
A supercycle is characterized by a prolonged period of rising commodity prices, supported by population growth and infrastructure expansion.
As you can see from the below chart, we have decades between each peak.
Understand how the commodity cycle works
I) The wake-up
At the initial stage of the commodity cycle, there is a surge in demand for commodity-related input. This increase in demand outstrips supply and results in a situation known as excess demand. It’s difficult to spot an excess demand that early in the cycle. Often the commodity price has been depressed for years, and suppliers have been shutting down or operating at a loss.
As I’m writing this article (June 2020), I’m starting to see uranium waking up. Is it the beginning of a strong bull run? A bunch of uranium producers has been wiped out during the last 15 years of the bear market. Furthermore, a couple of producers have used the excuse of COVID19 to close down production sites…
II) The raise
With time, prices will begin to rise, and companies will get easier access to capital to increase their production capacity. The higher demand will spur the increase in production, and prices will continue to increase even further. (June 2020) From my point of view, gold still has a decade long bull-run to go. I would put gold in the rising stage.
III) The bust
As producers increase their investment expenditure and capacity, the supply of commodities to the market increases. Furthermore, the capital to jump-start new production capacity becomes so easy to raise that anyone with a spreadsheet and good storytelling could raise millions.
The switch from the rise to the bust stage occurs when the incoming new production capacity in the pipeline starts to dwarf the current production in place. At this moment, you also begin to see record-high asset purchasing. This is when smart investors get out…
As of today (June 2020), I could not find a commodity that is in the bust stage. If Palladium recovers and reaches new highs before the end of 2020, I would categorize it in the bust stage. We’ll see…
IV) The fall
In the final phase of the commodity cycle, the market experiences an excess supply of commodities. The high prices have incentivized consumers to look for alternatives while a new massive supply stream arrives online. Consequently, prices begin to fall, and producers start to reduce spending. Production capacities are shutting down, and only the best ones manage to get financed.
This stage is the longest, and depending on the commodities could take decades to recover.
Now what?
Once you’ve understood that commodities have long-lasting cycles, it’s time to act on it.
As a young professional, always try to find a job in a depressed commodity. I know it may sound wired. But as the market recovers, you’ll be enjoying a long-lasting bull market and becoming a specialist in a field where there is currently less competition.
As an investor, even tho it’s possible to make money on every stage. Please don’t fall for the hype; for example, my current portfolio consists of gold mining stocks and a couple of bets on uranium. That’s it.
North American natural gas prices seem to be depressed given a mild winter and large injection period this past summer; supply exceeds demand. Based on your advice, ” as a young professional, aIways try to find a job in a depressed commodity” do you believe north american nat gas could be a depressed commodity in this context?
Hey! Yes, nat gas is depressed.
I should have added, for your first job take whatever you can!
Hey Damien , I am navigational Officer on commercial vessels… well actually I am onboard crossing Atlantic Ocean and I am following your advices . And planning to apply for some operational position in trading . Do you think my current position is somehow attractive for employers ?
Yeap, I’ve met a bunch of former officers in the commodity firm (in chartering, vetting, loss control, etc…).
Hey there,
thanks for the great explanation!
As we are in a down swinging market I am wondering what would be the next boost for an upswing. As global economies are loosing momentum due to Corona especailly boosting economies like China I wanted to ask for your opinion.
Will the market go further down next 5-10 years and swing back or can we expect an upswing any time soon caused by development in infrastrcuture/digitilization?
Best
Kine
Hey Kine!
I’m sure we’ll have a massive bull market in the next decades. Inflation will kicks in and we’ll see prices of commodities moving up.
Then the second wave will be the (re)-electrification, infrastructure will need to be rebuilt to cope with the EVERYTHING electric world of tomorrow.
Hi Damien ! I remember before Marc rich died , he said that the future is renewable energy , Do you believe in that ?
Hello Rud,
Humanity has never gone to less dense energy-base.
Nevertheless, I’m sure that with renewable (including nuclear power), we will have a grid denser in terms of energy production.
In addition, when you see the technological leap down in 10 years. It’s a no brainer that the future is going to be fully electrified with more than 50% renewable.
Hi Damien,
Would you be able to explain how a physical PNL book is constructed on your next blog? I am interested in how other firms measure their PNL and if there are any differences. I am at a small trading company that have inputs such as purchase and sales cost, gross margin, freight and carriage and financing. But when I hear about other companies they mention things such as VaR, delta which I do not understand. I thought these things usually apply in paper side of business and not physical. Any insights you can provide would be helpful!
Hello Johnny,
As far as I know, the PnL is on a trade by trade basis, it’s pretty much the same.
Are you talking about their risk exposure? => https://www.linkedin.com/pulse/managing-daily-var-commodity-trading-wongyu-choe/
How about coal and coke Guys? It’s depressing commodities for now?
Yes, depressed