Consequences of the Super Cycle downturn: changes for commodity nations, companies

Every day now media publish woeful stories of markets battling over-capacity, of investors fleeing a bear market, of governments desperate for revenue and of miners fighting for survival. Quite different from the expected ongoing bright future of a commodities Super Cycle that few had predicted. In this concluding article Mike Schussler, Director of South Africa’s leading private economic research house, describes the massive realignment of the world economy that will result from  long-term depressed commodity prices.

IT LOOKS LIKELY THAT the current fall in commodity prices will be one of the biggest on record and, with central banks printing money like never before, the real drop in commodity prices may be closer to 66% as similarly experienced between 1917 and 1931.

Mike Schussler
In every commodity Super Cycle, the rise in commodity prices is followed by over-supply that lasts for years as companies battle for survival by flooding the market and bringing costs down.

Remember Peak Oil? No? That is because in current prices, oil is cheaper than in 1981. Although storage costs are on the way up as there is too much oil, oil producers are still pumping like crazy to maintain “market share.” Their biggest enemy is other oil producers, not their customers. Witness the warm feeling Iran has towards the West and Saudi Arabia’s proxy wars against Iran.

Remember shortages of steel, iron ore and a host of other materials such as lumber and rubber? Now we have too much steel and, on current iron ore supply, could rebuild the world’s entire infrastructure in the next decade. Steel and Iron ore prices have fallen by two-thirds but even more supply is on the way.

Consumers have fat years ahead of them

The world has never before expended so little of consumer income for wheat, corn, oats and meat.

We have over 750 years of wheat price data and it has never been cheaper in real terms. Wheat was 6% cheaper at the end of 2015 than at the end of 1973 in nominal dollar terms!

The world has simply too much maize and wheat. Beef and chicken prices are dropping in USD terms too. By the end of the low commodity cycle, consumers in advanced countries may spend less than 5% on food.

If history repeats itself and the world is entering a period of 15 more years of low prices, the effects on emerging market economies will be huge.

I predict that most of the commodity prices falls are over but have another 30% to fall in real terms from end 2015 - which will be less than nominal terms but about 20% or so before a bottom is reached.

Greater economic impacts in Commodity countries

The hyper- or high-inflation that Germany suffered in the 1920s and 1930s and deflation elsewhere is also repeating.  Brazil and Russia have double digit inflation and Venezuela may have inflation higher than 100%! Switzerland is in a deflationary situation while the Eurozone, USA and Japan have very low inflation.

Image courtesy of Stuart Miles
The realignment of currencies is probably the biggest difference between the Great Depression and current weak growth. 

Currencies are acting as buffers for commodity exports and as further deflationary anchors for the developed world and China.

Debt levels also play a role in growth and, for some countries it will be the biggest issue but, for many emerging market countries, commodity prices will play the biggest role.

Rising unemployment in Brazil, Russia, Saudi Arabia and Africa will have political impacts too. Add the lower growth outlook to the Middle East and Africa and those two regions will again start falling back along with much of Latin America. That would allow the difference in income between the rich and poor countries to grow again. 

Asia will feel more positive as generally it is a commodity-consuming continent. But of course steel producers and much of heavy industry, such as ship building, will feel the same commodity price slump as will rice and other farm commodities.

Consumers in Asia will be much better off generally but the growth here too will be substantially slower and service industries will be the major growth driver – not construction or manufacturing and primary industry.

Interest rates will stay low in the developed parts of Asia such as Japan and South Korea and probably China but countries which are commodity producers, certainly Australia, New Zealand and Indonesia, will feel that their currencies are under pressure.

India will be different. She is getting ready to be the next new economic Super Power but any significant impact on commodity prices is still at least a decade away.

Not only will commodity countries suffer lower prices but their interest rates and inflation will rise. The impact will also be felt in that their current account and government fiscal balances will remain under pressure.

Just like any perfect storm these countries will also see ratings downgraded just as they need more money to cover shortfalls. Generally these are the parts of the world where population growth is still higher than average.

As this will not be a once-off situation and will continue well into the first part of the next commodity upswing; expect Europe and North America to continue to be approached by high numbers of refugees and economic migrants.

This will continue well into the 2030s and will have big impacts on housing, religion and social cohesion in the receiving countries. The brain drain of the developing world will unfortunately continue but over time tourism and remittances will grow strongly as well as some exports of local favourites.

The world changes in this part of the cycle

The “big man” syndrome along with “Dutch disease” will be off the radar for the next two decades and poor countries will get out of mining and services to mining. Privatisation will make a very big comeback as budget holes enforce sales.

The rich world will evolve in economic terms with new industries such as renewable energy and energy storage and new services. That will lift other newer commodities, perhaps lithium or other elements that will be used in energy or new industries.

The commodity world will have to find new ways to attract wealth and jobs. It will have to change to more value-added products and services which require better education and work ethic and allowing consumer businesses to grow.

Importantly, another 15 years of low commodity prices will result in totally different mining and agricultural companies, even more mechanised and automated and employing less people.

I also expect new products to rise to commercial success such as electric cars; new power storage methods, and new and better logistics and transport to emerge bringing new industries. I expect that Asia, North America and Europe to be central to these new industries which will then bring the new commodities to the fore.

New commodities could include Lithium Acid, Natural Gas, and others used in renewable energy, storage, composite materials and additive manufacture. I expect more chemical type commodities to come to the fore.

Some commodities will remain the same, such as wheat, meat, corn, gold and silver but the era of coal and oil, perhaps even iron ore and steel, is gradually coming to an end. Nothing is certain but the changes will be bigger over the next decade and a half than any other time in the last sixty-seventy years.

Commodities in decline will require larger operations to utilise economies of scale and to take advantage of innovations.. It will become more important for commodity countries to attract those majors and that will be those companies’ main strength for the next two decades. The bigger companies will also take over state-owned companies and bring modern management methods to play to increase productivity while containing costs.

Faster and smaller companies will develop the new commodity sector. As they will focus on growth, cost containment will matter far, far less to them.