The return of the supercycle

Last updated: Mar 10, 2021

Will the end of lockdown and the Covid-19 recovery mark the beginning of another supercycle, similar to the long period of growth that followed the emergence from the financial crisis, or will the recovery be short lived?

As with the financial crash of 2007-08, the pandemic triggered a deep recession, but there the similarity ends – the pandemic unleashed an unprecedented combination of economic shocks which not only saw an unparalleled reduction in economic activity, but also witnessed the collapse in transport activity, falling commodity prices, and the disruption of supply chains1. As the global economy emerges out of the shadow of the pandemic, many are predicting a rapid ‘v’-shaped recovery – heralding the onset of a new supercycle.

While talk of a supercycle is premature, a growing number of analysts, including US bank Goldman Sachs, think that the post-pandemic recovery will kick-start a sustained period of rising commodity prices, increasing capital expenditure (‘capex’), and above-trend economic growth. Of course, even at the height of the pandemic, construction projects were largely unaffected, food stores kept selling, and Amazon kept delivering – all providing a buffer against a prolonged recession and setting up the possibility of a supercycle.

What are supercycles?

Supercycles are economic and financial cycles that are much longer than cycles associated with the ‘normal’ ebb and flow of economic activity.

Supercycles are associated with fundamental changes in underlying economic structures, including the emergence of new industries, changes in knowledge and technology, new product types, and structural changes in demand. Supercycles are likely to involve long term changes in relative prices of goods and services, especially involving increases in the price of commodities and financial assets, and rising equity markets.

Changes within a supercycle may be slow and perhaps not obvious to analysts at the time, but the changes that happen are significant and long lasting.

Previous supercycles

Kondratiev cycles

According to analysts at Alliance Global Investors2 there have been five supercycles since 1780, including the ‘Ages’ of Steam, Railways, Electrification, Autos and Petrochemicals, and Information Technology. The sixth is considered to be the Age of ‘Environment Technology, Nano and Biotechnology and Health Care’. Of course, this was written in 2010, shortly after the end of the financial crisis, and a decade before COVID-19.

Kondratiev and Schumpeter

While supercycles or K-waves (after Russian economist, Nikolai Kondratiev3 ) have been widely studied in economics, there is little agreement on what causes these cycles, when they begin and end and how long they last.

Kondratiev himself considered changes in metal prices (particularly copper prices) to be significant in explaining the timing and progression of these cycles. Today, copper prices are still regarded as a barometer of commodity prices in general.

Kondratiev’s ideas on the nature of economic cycles were developed much further by Austrian economist Joseph Schumpeter4 who identified innovation as the key driver of business cycles. According to Schumpeter, economic cycles are inevitable in capitalist systems, and involve new technologies replacing older ones through a process called ‘creative destruction’. This involves ‘new’ risk-taking entrepreneurs gaining a competitive advantage by using, or developing new technologies which eventually replace ‘old’ technology and displaces existing firms. These firms, in turn, will be displaced by newer firms employing even more innovative technology. Hence, creative destruction ‘clears the way’ for new cycles of long term growth.

While highlighting the importance of risk taking entrepreneurs in the driving innovation, Schumpeter also recognised the importance of the availability of capital, and the role of financial markets, and innovations in these markets. As Arun Motianey puts it in his seminal work on supercycles, ‘supercycles tell capital where to move’5.

So how do commodity supercycles work?

Commodity cycles exist because of the rapid speed of change in demand for commodities relative to changes in supply.

Demand for commodities, such as metals, are derived from the demand for finished goods – such as motor vehicles and computers – and from the demand for private and social capital, such as office blocks and roads and bridges. Demand for these can increase relatively quickly – resulting in a demand-side shock and accelerating commodity prices.

For example, as economies recover from the effects of the pandemic, demand for motor vehicles and new homes can increase quickly – especially as households start to spend again following many months of saving and general belt-tightening – so-called ‘pent-up’ demand. Business investment that was put on hold can now come on stream. While increases in demand may continue for several years, fuelled by a positive multiplier effect, there is evidence that growth in demand is non-linear, and will reach a plateau eventually declining.

However, unlike many other markets, the supply of commodities is likely to be slow to adjust, with a relatively low elasticity of supply in the short run. This depends upon the level of stocks that have been built up. However, developing new supplies of commodities takes time - to explore, extract, process and sell - perhaps up to 5 years. As a result of the supply-lag, excess demand will trigger price increases, which may induce innovation in the production process, and also encourage new entrants – both of which will increase supply in the longer term.

If we consider this graphically, and take the example of copper, we can assume a stable equilibrium at point ‘a’ with demand and supply at D1 and S1, and with price at ‘P’, and with quantity at ‘Q’ with a small working quantity of stocks. The supply curve (S1) is shown as relatively inelastic.

Diagram for copper prices

The initial demand-side shock shifts demand to D1, with a modest expansion of supply (up to point ‘b’) to meet this increase in demand. However, supply is insufficient to prevent price from being driven up to P2 – this begins the upward trend of the commodity cycle.

Assuming the demand side shock is sustained (through continued increases in the demand for housing, office blocks or infrastructure and so on, shown as D2 to D4) price also rise, from P2 to P4. This will provide an incentive for commodity producers to find new sources of the commodity, or apply new technologies to the production process.

As supply eventually comes on stream, the supply curve for the commodity shifts to the right – to S2. Even though demand continues to increase (D5 to D6) the increase in price (P4 to P5) begins to moderate, and the price path begins to turn at ‘c’. What happens after that depends upon the path of demand relative to supply. But what is clear is that the acceleration of commodity prices (shown in the price path) is likely to slow down, and reach a plateau. As Arun Motianey points out6 commodity supercycles are inherently disinflationary – the rate of increase in commodity prices slows down, with the potential to end in deflation. However, a supercycle for commodities means that the plateau and even the downturn do not materialise for many years.

A new supercycle?

Returning to supercycles and the impact of the pandemic, Jeff Currie, head of Commodities Research for Goldman Sachs Research, sees the pandemic as a ‘structural catalyst’ creating a social crisis which has forced policy-makers to shift their focus on social needs.

This means it is likely that ‘stimulus’ policies to build a recovery, including the eye-watering $1.9trillion rescue package for the US, will proportionately benefit the less well off. The impact of this will be to increase demand for commodities as a simple matter of mathematics – there are more consumers in the groups that will benefit most from any stimulus package. These lower income consumers have a relatively high marginal propensity to consume, and demand for commodities – derived from rising demand for goods, building and construction, and capital expenditure – is highly income elastic – as incomes rise in the post-pandemic economy demand for commodities rise by a greater proportion.

This means that recovery from the pandemic will be different from the recovery from the financial crisis, where the stimulus was more narrowly focused on the financial system, and where beneficiaries had a relatively low marginal propensity to consume.

In the previous long wave – which ended with the financial crisis – metal prices were driven up by the rapid industrialisation and urbanisation occurring in the BRIC economies - notably, China. For example, between 2000 and 2011, copper prices rose from $2000 a tonne to over $10,000. It was only the impact of the financial crisis that put the brakes on this trend.

A similar post-pandemic wave might well be seen across all commodity markets, given that demand exceeds supply capacity for most commodities. Added to this is the movement towards a ‘green industrial revolution’ and the push for decarbonisation which will put added pressure on scarce resources. The push for full employment as part of the Covid-recovery is likely to re-enforce the impact of other social policies.

It does seem that many of the necessary conditions are in place to trigger a new supercycle. These include: the release of pent-up demand, the return to work, and the impact of social policy. These are likely to be sustained and supported by real increases in both private and social capital spending. All of this will trigger commodity price increases and wider inflationary pressure, which make commodity stocks even more attractive as a hedge against inflation.

Exactly how the post-pandemic recovery will act as a catalyst for a possible supercycle is unknown – will innovations associated with vaccine technology kick-start a new Age of healthcare, or even a ‘healthcare revolution’? Will this find itself merging with the ‘green revolution’ and financed by cryptocurrencies, or other financial innovations? Will new firms emerge to exploit new technologies, or perhaps even create them? As with all supercycles, they are best described, explained and understood through the lens of hindsight.

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Supply-side policy

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Supply-side policy

Endnotes and sources

Rajput, Himadri et al. “A shock like no other: coronavirus rattles commodity markets.” Environment, development and sustainability, 1-12. 11 Aug. 2020, doi:10.1007/s10668-020-00934-4)

Alliance Global Investors, ‘The Sixth Kondratiev – long waves of prosperity’ (2010) link

Nikolai Kondratiev, 1892–1938

Arun Motianey, ‘Super Cycles – the New Economic Force Transforming Global Markets and Investment Strategy’ McGraw Hill, 2010, pviii

Joseph Schumpeter 'Capitalism, Socialism and Democracy',1942

World Bank, Policy Research Working Paper 9122, The Role of Income and Substitution in Commodity Demand by John Baffes, Alain Kabundi, Peter Nagle, Prospects Group January 2020.

Arun Motianey, ‘Super Cycles – the New Economic Force Transforming Global Markets and Investment Strategy’ McGraw Hill, 2010