A super cycle is a prolonged trend rise in real commodity prices. The recent trend of rising commodity prices after a long period of depression (before the world market turned topsy turvy, post Lehmann Brothers’ collapse) indicate that the world might have entering the bullish phase of a super-cycle. It is however difficult to say with certainty, at this juncture, whether we have entered a super cycle phase or not, but rising demand from developing Asia, particularly China and India, if sustained, will certainly drive prices higher in the coming years.

Something exceptional has been going on in the world of commodities. The prices of almost all the commodities - fuel as well as non-fuel - have witnessed an upward trend since 2000 after an entire decade of depressed prices. Oil prices rose seven fold between 1999 and 2006, metal prices have soared and touched their all time peak in either 2006 or 2007 and the same can be said for precious metals. Agricultural commodities have also shown a similar trend. Though prices of agricultural commodities have lagged metal and oil prices in terms of percentage gains, they have also hit new peaks. Rising commodity prices following a prolonged period of depression has attracted attention towards the probability of the world entering a ‘commodity super cycle’ phase.

Cycles are basically fluctuations in the economic activity about its long-term growth trend and are an inherent feature of any economy. In economics, when we speak of cycles we generally tend to relate to ‘business cycles’, which typically last 7 to 11 years. In addition to this, we have shorter waves lasting for a smaller period of 3-4 yrs. However, this is not all - there are reasons to believe in the existence of long waves of an average length of about 50 years in the capitalistic economy.

This idea was first propounded by Nickolai Kondratieff, a Russian economist (1892-1938) in Stalin’s Agricultural Academy and Business Research Institute. Kondratieff’s major premise was that capitalist economies displayed long wave cycles of boom and bust ranging between 50-60 years in duration (”Long Waves in Economic Life” - originally published in German in 1926) Statistical work on the behavior of prices and output series for the United States and Britain since the 1790s, led him to conclude that the existence of long waves was very probable and this pattern of long cycles spanning to 50-60 years came to be known as K-waves. He identified four distinct phases an economy goes through - a period of inflationary growth, followed by stagflation, then deflationary growth and finally depression.

Kondratieff’s study covered the period 1789 to 1926 and was centered on prices and interest rates. He argued in books and papers that long waves in economies and prices are inherent in the capitalist system and that commodities move in 50- to 60-year cycles. Upswings are caused by increased capital investment, and downswings arise as those investments lose value. New markets and new technologies also push prices up during the expansionary phase.

He observed three upswings in commodity prices: 1789 to 1814, spanning the French Revolution and Napoleonic wars; 1843 to 1864, an era of European industrialisation; and 1896 to 1920, when the United States emerged as the world’s largest economy. Each was followed by a commodities decline of between 23 and 35 years. The average decline lasted 29 years, the average upswing 24 years.

Using Kondratieff’s analysis to project forward, a 29-year slump was due from 1920 to 1949 - a span that includes the Great Depression and World War II. A full 53-year up-and-down cycle followed, making another upswing due in 2002, which the world is probably witnessing at present and which is likely to last for at least another 15 to 20 years.

What is a super cycle?

A super cycle is a prolonged (decades long) trend rise in real commodity prices, driven by the urbanisation and industrialisation of a major economy (or economies). High and rising intensity of metals use is the most useful indicator of a super cycle. It is believed that highly materials-intensive economic activity is the cause of super cycles. This is because a rise in the economic activity is reflected in rapid industrialisation (leading to higher growth), which is metal and oil intensive. Almost all periods of large upward movement in metal consumption and prices have been associated with strong world growth.

Over the years some economists have observed that there are phases of economic activity, where waves of expansion and growth are followed by slowdown and recession, and that these phases can be quantified in terms of duration. Kondratieff was the most famous exponent of this approach in the 1920s while in the US, Dewey and Dakin took up the theme in their book “Cycles - The Science of Predictions” published in 1947. In both the cases, a long wave (or super cycle) is posited as lasting between fifty to sixty years in which we move from trough to peak and to trough again. Within the long wave there are smaller waves, in which activity ebbs and flows in briefer time periods. All of these studies focused as much on the historical analysis of commodity prices as on interest rates, trade, inflation and the rest of the available economic data.

There have been 5 commodity bull markets in the past 200 years, with rhythmic frequency. The longest has been about 40 years with the shortest at 15 years.

1st boom-1823 to 1838 (15 years)
2nd boom-1848 to 1865 (17 years)
3rd boom-1878 to 1918 (40 years)
4th boom-1929 to 1950 (21 years)
5th boom-1963 to 1980 (17 years)

During each up-cycle, the prices of commodities  increase, so more producers get encouraged to expand capacity and supply more products. However, during the down-cycle the prices of commodities decrease, squeezing the profits of the producers, eventually pushing many out of business.

As the next up-cycle begins (many years later) there is a lag time involved as the producers still remember the pain of the last down-cycle and how every expansion they tried was met by declining prices. Not until they have seen the new trend firmly in place do they typically spend the money to increase production. Once they have decided to increase production then there is another time lag,since new production cannot happen immediately.

In the case of agricultural commodities a shift from one product to another can happen relatively quickly. The farmer just plants a different crop in his field. However, in the case of metals it is a far more time consuming process. New mines take years to refurbish (or find) and millions of dollars of equipment to get them to being productive. Meanwhile, the demand for the metal continues to increase causing the price to increase. In reality, all economic cycles and wave patterns are best identified with the benefit of hindsight and forcing current circumstances into some pre-ordained mould is a dangerous forecasting mechanism.

As commodity prices have started to rise from the last bear market there is a general consensus in the commodity world that “Commodity prices are approaching all time highs”. While in nominal terms (not corrected for inflation) this is technically correct, it is not true in real terms. Despite recent rises, the prices of most commodities remain below their historical peaks in real terms. A U.S. Dollar in 1981 used to buy a whole lot more “stuff” than it does today. In other words, it was worth more than a dollar is worth today. To get a grasp of where commodity prices really are today one has to consider inflation. When inflation is taken out of the picture we get a realistic view of the prices of commodities, and correcting for inflation one would find that the prices are nowhere near all time highs, as proclaimed.

It is rather tricky to answer if the prices are going to touch all-time peaks in real terms or whether we are actually into a phase of commodity super cycle. What one can say with certainty is that unless an unforeseen catastrophe occurs and the world economy is plunged into a global depression (are we already into it?), the relentless demand for industrial materials of all kinds from countries like China and India is set to continue.

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Tags: Commodities, cycles

This entry was posted on Tuesday, November 25th, 2008 at 3:57 pm and is filed under Global Economy, Indian Economy. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.