Investment Week, 10 May 2021
Matthew Read, senior analyst, QuotedData
History shows that commodity cycles tend to be long. Back in the summer of 2019, Robert Siddles, then the manager of what is now Brown Advisory US Smaller Companies, joked with me that commodity cycles tend to have ten up years, then 18 down years, so, with the last up cycle starting in the early 2000s, he planned to start looking at them again in 2027! In reality, the pandemic appears to have moved this date forward, as explained below. But why do commodity markets have such elongated booms and busts? And, more importantly, where are we today?
Taking the first question, commodity extraction tends to come with high fixed costs – sinking shafts and drilling wells is time consuming and expensive – and so it takes considerable effort to bring on new supply. In economist language, at least in the short term, supply tends to be price inelastic. Consequently, when demand is strong, commodity prices can move up very quickly – cue the early 2000s when China was investing very heavily in infrastructure. Prices rose very quickly, and remained elevated for a long time, and commodities were a superb place to be invested. Inevitably, however, high prices will encourage new supply to enter the market over time, bringing the equilibrium price down. That does not explain though, why commodity downturns tend to last so long.
Read more here