The main fundamental drivers of the commodities supercycle are still in force and recent commodity price weaknesses are more related to business-cycle fluctuations and short-term commodity-specific supply increases than a change in structural fundamentals.
Resource-intensive economic growth in emerging markets, led by urbanisation and industrialisation, has been the main force behind the rise in commodity demand and prices in the past 10 years.
This process is expected to continue for the next 10 to 20 years. The rise in commodity demand in the past 10 years has occurred most strongly in China and India. Both remain in the early stages of industrialisation and urbanisation. With per capita GDP in these countries projected to triple by 2030, absolute demand for the commodity inputs necessary to produce the investment and consumption goods they will demand in this period is expected to be significant.
The size of the middle class in emerging markets is expected to rise at a rapid pace in the next decade, and with it so will their consumption of commodity-intensive goods. Offices, middle-class housing, automobiles, roads, trains, airports and related infrastructure, refrigerators, washing machines, computing devices and meat for example are all highly commodity intensive to produce. Even as the economic growth of some emerging market countries becomes less manufacturing-led and more consumption-led, the absolute demand for commodities is expected to continue to rise.
However, the long-term supply of most commodities will remain constrained due to their increasing scarcity and rising costs of production. As a consequence, higher commodity prices will be necessary to ensure that supply meets demand.
The costs involved in oil extraction and mining are set to rise. For example, with oil fields in current production rapidly depleting, more remote and expensive oil fields will have to be developed to meet rising energy demand.
According to BP forecasts, world primary energy consumption will be 36 per cent higher in 2030 than in 2011. Similarly the cost involved with metals mining are increasing, driven by rising energy, machinery and exploration outlays, as well as labour constraints. As mining costs rise it becomes uneconomic for companies to produce and explore, unless prices continue to rise to cover these costs. Higher prices will incentivise the efficient use of the world’s scarce resources and the investment and innovation necessary to boost high cost exploration and supply productivity.
Increasing wealth in emerging market countries will drive commodity consumption and investment in the longer-term, and supply constraints will likely keep upward pressure on prices.
Nitesh Shah is an analyst at ETF Securities