Growth cycle of the commodity market: will it be different this time?

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From the beginning of 2024, the commodity market has continuously grown — even surpassing the growth rate of the stock market. Few people know that the rise and fall of commodity prices actually follow the basic supply-demand balance cycle, an introductory theory of Economics.

However, talking about the recent hot growth of the raw materials market is different. Will the growth of the raw materials market follow the rise-fall cycle like ordinary commodity markets? And will that cycle be short-term or long-term?

While waiting for the June FOMC next week, this week's Macro Economics column of Viet Hustler will “take a break” from comments on the big macro picture of labor - inflation - recession. Instead, Viet Hustler will delve deeper into the smaller macro picture in the commodity market.

Disclaimer: Part of the article below contains personal opinions — and is not investment advice. Some technology industry terms may not be used accurately due to the author's limited knowledge.

Commodity Market: Boom and Bust Cycle (Boom - Bust Cycle)

The idea about Boom-Bust Cycle below is excerpted from the article by Lance Robert:

• Quite similar to the warnings in Viet Hustler's article on the relationship between the commodity market and inflation. 

Michael Hartnett – Head of Research at BofA once emphasized:

The 40-year period (1980 - 2020) was the era of disinflation:

• … the market witnessed “deflationary assets” (government and corporate bonds, S&P, growth stocks) having superior growth over “inflationary assets” (cash, commodities, TIPS, EAFE, bank deposits and old dividend-paying company stocks). 

  • 'Deflationary assets' had an average annual growth of 10% vs 8% growth of 'inflationary assets' during this 40-year period.

• But the regime change in the past 4 years has reversed the above situation: currently, “inflationary assets” are delivering 11% annual returns compared to 7% for deflationary assets.”

And as mentioned above: the commodity market is one of the “value assets in inflation times"!

• The boom - then bust cycle of the commodity market always occurs at historical crisis and inflation moments:

  2000 - 2002 - 2004/05 - 2007 - 2016 - 2019 - 2021/22

  • The common point is that commodity prices will surge and then drop to the bottom.

• Furthermore, this “boom and bust” cycle has continuously repeated since the 1970s:

  • … with many periods where commodity prices rose to unimaginable highs and then fell to new lows lower than previous bottoms.

So why do commodity prices tend to boom easily (boom) and then bust like that?

The typical price cycle (supply-demand balance) of commodities leads to the boom-bust phenomenon:

1. The initial stage of commodity price increase (boom) occurs when: demand increases exceeding the current supply. 

   • For example, in the typical orange juice market: drought or pests… cause orange supply to decrease compared to demand.

2. Because commodity prices (e.g. orange prices) start to rise high, speculators on Wall Street start buying many Futures contracts:

   • …. pushing prices even higher to unimaginable levels (boom).

3. However, because prices are high, suppliers will increase exploitation/production/supply of commodities.

   • Example: farmers will stop planting lemons and switch to planting oranges… 

4. => This causes supply to increase again and commodity prices to cool down.

5. However, when speculators first notice the supply increasing, they will sell their Futures contracts (even short-selling futures contracts)…

   • …. this causes commodity prices not only to normalize but to suddenly plummet (bust).

6. However, when commodity prices fall, suppliers will cut production again -

   • (OPEC+ cuts oil prices, farmers don't plant oranges but go plant lemons)...

     => the boom cycle returns because supply decreases again!

Commodity prices also come with inflation cycles:

• High commodity prices will push inflation higher: most inflation episodes are due to supply shocks reducing supply or surging demand (making supply < demand).

  

• However: "High prices are also the cure for inflation" – Prices too high cause demand for commodities to decrease – people cut spending:

  • After commodity prices rise sharply, the next is a slowdown in the economic growth rate – simply because consumption drives ~70% GDP.

  

• With the current Covid-induced inflation cycle, this is only true for the commodity market (commodity deflation has occurred). 

  • Service inflation remains persistent due to high post-Covid service demand and people still having excess savings

  • … however, the service disinflation cycle will soon occur when spending is cut.

• Moreover, the sudden drop in commodity prices (bust) after the miraculous price increase cycle (boom) is always an early sign that the economy is preparing to enter a recession:

  

Will this cycle be different?

The boom in AI stocks and the raw materials market

Above is a normal boom-bust cycle for commodities. The time for each boom-bust cycle is usually different for different commodity groups:

• For example, agricultural products have cycles by year…

The “boom” situation in the raw materials market in recent days is also not outside the above supply < demand rule….

• but placed in the context of a demand increase cycle where supply will be limited for much longer!

Indeed…!

Last year, the boom in tech stocks was the center of the rally wave on the stock market: and contributed to improving labor productivity in the US

• The tech sector accounts for 31% weight in the S&P500 basket.

• GS estimates that the generative AI boom has led to a ~+15% increase in US labor productivity and GDP.

  • The adoption of AI technology is widespread in most technology sectors.

    

• And the center for the AI wave is Nvidia: illustrated by a cartoon that Viet Hustler quite likes as below.

  • When tech giants rush to “go gold digging” (a.k.a. exploiting internet platforms and AI technology)….

  • … Nvidia supplies them with gold digging shovels (GPUs, APIs, AI chips…).

However, the AI technology boom may also be limited by the grid's power capacity to deliver those technologies:

• Forecast by 2026 - demand for electricity for data centers and crypto will nearly double compared to 2022.

  

• In the US, energy demand is rising sharply at locations with large data centers:

  

• Electricity demand from that also explodes as technology booms:

  • Electricity demand for small things like Bitcoin mining…

    

  • … or the demand for electricity for larger purposes like Generative AI continues to increase relentlessly:

    

Building a sufficiently strong power grid to support developing technology has also become a race among major powers:

• Project National Integrated Computing System (全国一体化算力体系) is one of China's key priorities emphasized in the Two Sessions meeting in early March 2024.

• In central Massachusetts, USA, helicopters are also being used to inspect the National Grid:

  

This leads to the construction and reinforcement of power grid systems in developed countries – which is the surge in demand for raw materials:

• Prices of Futures contracts for silver, gold, tin, nickel, copper, zinc… are rising sharply – especially in the Chinese market.

  

• Therefore, this “boom” cycle in the raw materials market comes from the very demand to strengthen the aforementioned power grid systems. 

And for this cycle to “bust” … it seems it will take a bit more time.

• Because even if a recession occurs, the demand for electricity for data technology and AI is unlikely to decline too much.

CONCLUSION

Price cycles in the commodity market originally stem from the basic supply-demand balance of goods — this is basic introductory Economics knowledge. However, for commodity prices to surge dramatically and then plummet severely (Boom-Bust Cycle) from the 1970s decades onward, it must be attributed to the increasing popularity of derivative securities allowing speculation in the market.

And of course, goods inflation is completely controlled by the price cycles in the commodity market. It's no coincidence that orange juice prices became a classic economic example of inflation. In fact, service inflation also follows this supply-demand balance rule. It's just that this service disinflation cycle is slower because consumer demand remains high post-Covid and they still have excess savings in 2023.

According to Viet Hustler's view, the recent increase in raw material prices is also not outside the supply-demand balance rule… but the demand here is no longer simply ordinary household demand. This surge in raw material demand is more macroeconomic… at the level of policy orientation for technology development and competition among developed countries.

Therefore, the “bust” phase of the raw materials market may come later … or may not come at all if the supply of raw materials is depleted!