A sharp reversal in commodity prices – hitting everything from copper, to crude oil, to wheat – is sapping investor enthusiasm for the resource sector and dismantling predictions of a supercycle that would immediately reshape the global economy.
As in many speculative booms, rising interest rates are largely to blame for the pullback. But investors are equally culpable, after they fell for age-old commodity price hype – no matter how many times they’ve already been burned.
The price of copper, often cited as a barometer of global economic health, has dropped by one-third since setting a record high near US$5 a pound in March, while the closing price of nickel is down more than 50 per cent over the same time period.
Brent crude, the benchmark for international oil, has dropped 16 per cent in little more than a month, and the price of wheat, which shot through the roof this spring, has dropped 36 per cent since mid-May.
The pullback is a blight on commodity analysts and traders who pushed the theory that a new economic order was blossoming, one that would power a supercycle reminiscent of the first few years after the 2008-09 global financial crisis.
In many ways it is a familiar story. Commodity prices are notoriously cyclical – the postcrisis supercycle crashed as well. And because Canada is rich with natural resources, investors here have endured these peaks and valleys many times.
Usually, however, these cycles play out over several years. The current one is reversing in a matter of months, and natural resource producers, whose share prices tend to rise and fall in tandem with their underlying commodities, are ricocheting as a result.
As of early June, shares of Vancouver-based Teck Resources Ltd., a major producer of metallurgical coal and copper, had gained more than 50 per cent this year, hitting $57 apiece. There was even speculation Teck could soon hit $100. But over the past six weeks, Teck shares have plummeted 40 per cent.
The current cycle is imploding despite missing a signature feature of previous busts: production increases. So often, growing commodity supply ultimately pushes down prices. Instead, the recent boom is unwinding largely because people who hyped it underestimated inflation and the resolve of central banks to fight it.
“Interest rate expectations have become a lot more hawkish than anyone would have expected back in March,” said Bart Melek, head of commodity markets strategy at TD Securities. What forecasters in the commodities sector got most wrong, he said, was the willingness of central banks to hike interest rates aggressively to stamp out inflation.
Higher rates have not only dampened global growth expectations, hurting demand for metals and energy, but they have also spurred speculators to flee the sector, similar to how, just recently, they cut and run from riskier industries such as crypto and technology.
To be clear, many commodity prices are still higher than where they started the year, including oil, which is near and dear to Canada’s economic growth. But the broad resource correction is completely at odds with the breathless predictions of a supercycle during the first quarter and through the spring.
Much of the hype was driven by forecasts of limited supply of many metals, and oil and gas, at some point in the future. Before the COVID-19 pandemic hit, institutional investors and activists demanded more action on environmental, social and governance (ESG) issues – the sustainable investing movement – and that made it difficult for natural resource producers to expand.
In one notable example, Teck came under siege just weeks before the first hard COVID lockdown in March, 2020. At the time, the company was seeking federal approval for its undeveloped Frontier oil sands project in Alberta, and the backlash from opponents was so fierce the issue quickly morphed into a political mess.
Because the global economy started humming when the first Omicron wave subsided early this year, analysts and traders looked out a few years and assumed that constrained commodity supplies wouldn’t keep up with growing demand. Add to that the hopes and dreams for electric-vehicle production, because car batteries require a number of metals, including copper, and there was almost no taming expectations.
In January, global investment bank Citigroup started calling for a supercycle for copper. “For the first time since the 2000s copper has a structural demand growth driver – the world’s accelerating decarbonization drive,” analysts wrote in a note to clients. A month later, Bank of Nova Scotia analysts threw their weight behind the wave – but they went even broader, saying that tight commodity markets of all stripes were brewing an “impending supercycle.”
Everything went berserk when Russia invaded Ukraine in February, and then as spring dragged on, major economies, including Canada and the United States, reported strong growth, resulting in even more froth for demand expectations for natural resources.
“The amount of money flowing into commodity funds, the amount of money flowing into the commodity ETFs was extraordinary,” said Virginia-based commodities specialist Dennis Gartman, former editor and publisher of The Gartman Letter. “The amount of press appearances of commodity traders became endemic, and it’s always illustrative of highs in markets.”
What the traders didn’t foresee was that central banks were turning aggressive. Hiking rates slows demand across the across entire economy, and that can cause a recession. But reducing inflation became the ultimate goal – hence, the Bank of Canada’s full-percentage-point hike last week, its first since 1998.
“Even if we don’t get massive demand declines from this economic slowdown, it doesn’t mean [commodity prices] can’t go down in the near term,” said Rory Johnston, who writes the Commodity Context newsletter. Speculators had piled into natural resources, and the narrative shift prompted many to cash out.
At the same time, China’s economy remains hobbled because of continuing lockdowns and gross domestic product shrank 2.6 per cent in the second quarter relative to the first, significantly worse than expected. China’s struggles have had an outsized effect on copper, because it is used in a lot of real estate development.
A strong U.S. dollar is also weighing on commodity prices. The greenback is now extraordinarily expensive relative to many currencies, which makes it more expensive for foreigners to buy commodities – again, sapping demand.
While the commodity crash has been swift, producers themselves are still benefiting from soaring profits. Energy producers, for one, are flush with cash.
The problem for resource supply is that there aren’t many places for this excess capital to go. Many producers promised investors they wouldn’t spend wildly on acquisitions or new developments. Excess spending led to the supercycle crash a decade ago, resulting in tens of billions of dollars’ worth of mining acquisition writedowns. ESG concerns also loom large.
It’s why some analysts are still predicting a commodity bull run – but over the long term, not the short. In recent weeks Jeff Currie, global head of commodities research at Goldman Sachs, told CNBC he believes this is just the first inning of a supercycle, because “the sector has suffered from a decade-plus of underinvestment.”
But commodity producers are caught in a Catch-22. When prices soared this year, there were pleas from some quarters to boost production – particularly of oil and gas, to offset Russia’s sanctions. However, hardly any producers said they could. For one thing, massive capital projects can’t be flipped on like a light switch. There were also fears commodity prices could correct, which would make new projects less economical.
This circular problem is what makes aggressive rate hikes to tackle inflation so tricky. The world likely needs more resource development for a few more decades, but softer demand makes expansion projects less valuable. “The challenge is that we’re going to need higher prices to get that supply,” said Mr. Johnston of Commodity Context.
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