Something went wrong with the commodity cycle during the year after the financial crisis of 2008, and that something may explain why the recovery took so long. Now there are reasons to believe that this time the commodity cycle is turning. That is good news for commodity importers everywhere – and that includes the UK. It is not so good for commodity exporters, however – expect tears in Brazil and Russia, for example.

On paper it is supposed to work like this. Commodity price are high, therefore commodity producers – be they oil companies, miners or in the agriculture sector – invest and try new ideas, until eventually supply increases, forcing the price of commodities down. Cheaper commodities mean that commodity producers invest less, supply falls – or at least fails to keep pace with demand – until price rises, and the cycle begins again. That is how cycles are supposed to work in business, the economy and nature. See: Arctic Hare and Lynx: the business cycle working in nature 

Lots of theories are put forward to explain why the recession of 2008/09 was so nasty, but it is possible that we just suffered a perfect storm: a banking crisis, too much debt, and commodity prices at record highs.

Price collapsed in late 2008, as the theory of commodity cycles said it should have, and the UK, the US and Europe came out of recession. So far, so very predictable.

Then in 2010/11, things went topsy turvy. Commodity prices rose again, oil surged from around $35 a barrel, to over $100 within 18 months. The UK and the EU went back into recession. Some believed it was as a result of peak oil – that is to say that oil production had permanently peaked. Others looked at demographics, at the rising population, and said: “Well, that’s it then. This time it is different, the cycle has broken down forever. We have simply used up too much of this planet’s scarce resources.”

The pessimists may have been overlooking something. The recession of 2008 had multiple causes, amongst them a banking crisis, and the banking crisis meant lack of demand and lack of finance, so the normal rise in investment in commodities – which occurs when prices are at a new high – didn’t happen, not at first, anyway.

It is different now. According to the latest Statistical Review of World Energy from BP, 2012 saw the largest increase in oil production ever recorded.
You don’t need to look far for an explanation. Massive investment in shale gas and oil, especially in the US, into this particular resource is as far as you need to go.

In other words, the cycle is at last working the way it should.

This is how the World Bank put it: “Since early 2011, industrial commodity prices have been weakening, a process that appears to be intensifying in 2013, despite signs that the global economy is gaining strength Indeed, since their peak in early 2011, the price of metals and minerals is down 30 per cent and that of energy is down 14 per cent, with prices off 12 and 5 per cent, respectively, between January 2013 and the end of May 2013. This price weakness has sparked discussion about whether a super-cycle in commodity prices is coming to an end—particularly within the metals industry, where large increases in supply are coming on stream in response to investments spurred by the high prices of the past several years.”

If the idea that the super-cycle in commodities has turned and prices are set for an extended period of falls is right, then this is good news for commodity importers – such as the UK, US, most of Europe, China and most of South East Asia. It is not so good for most of Latin America, although Mexico is less vulnerable.

But is this really good news? If you still sign up to the idea of manmade climate change, then that means you probably want energy prices to stay high for a little longer, while investment in renewables grows. The shale gas and oil miracle may not be quite so good for Earth PLC, or Gaia.

© Investment & Business News 2013