Commodities Supercycle Looks Like A Stretch

Commodity markets are roaring, stirring a debate about whether prices are headed for an extended upswing. The history of booms and busts in raw materials suggests the conditions aren’t right.

Prices for Brent crude, the international benchmark in energy markets, have jumped 82% since the end of October. Copper is more expensive than it has been since 2011. Food hasn’t cost as much since 2014, according to a United Nations index.

Some investors and analysts say commodities are in the early stages of a supercycle. That is a period when prices of livestock, grains, metals, oil and gas all climb for years, even decades.

A prolonged upturn would present investors with an opportunity to make money from long-term bets on exchange-traded products that track commodity prices. Such vehicles bloomed in popularity when commodity markets soared in the 2000s and early 2010s, only to fall out of favour when prices tanked in 2014.

But the chances of commodity prices rising in tandem over a long period are slim. Such cycles are rare. They have occurred when a major economy such as the U.S. or China undergoes rapid industrialization or urbanization, creating demand for raw materials that existing supplies struggle to meet.

Economists say they don’t see a similar catalyst right now. A swift expansion in the global economy this year and next is likely to power demand. Beyond that, many analysts see oil consumption, in particular, slowing down.

“It pays investors, it pays policy makers to be a little bit sceptical of characterizing the developments of the past six to 12 months as the seeds of a new supercycle,” said David Jacks, a professor at Singapore’s Yale-NUS College who has studied the history of commodity markets.

Commodity prices are an important barometer for financial markets. Rising gasoline and energy costs contributed to a modest increase in the rate of U.S. inflation earlier this year. Expectations of a leap in consumer prices sent bond yields surging in recent weeks and cooled corners of the stock market.

When resources’ prices swing higher for an extended period, one of three things happens. The first is an economic shock, such as the recession in the 1970s, caused in part by the Arab oil embargo. The second is a rush of supply as miners, energy producers and farmers seek to cash in. Over time, people switch to cheaper alternatives.

Adjusting for inflation, U.S. crude prices in 2020 were well below their peaks from 2008 and 1980, though they were more than double the 1945 level, according to data compiled by Mr Jacks. Inflation-adjusted grain prices have dropped since World War II due to advances in crop science, Mr Jacks said.

The last supercycle occurred from the late 1990s, when a rapid expansion of cities and industry in China unleashed waves of demand for natural resources, according to Daniel Jerrett, chief investment officer at Stategy Capital LP. Supply was slow to respond and commodity prices, adjusting for inflation, shot up.

“Is there anything out there like that now? I don’t see it,” Mr Jerrett said.

The China-led supercycle kicked off with crude-oil and copper prices at their lowest level in more than a decade. That isn’t the case now: Copper prices, for instance, are close to record highs.

The current outlook for commodity prices is especially complicated because of a number of competing forces.

Some commodities have been swept up in the “everything rally’’ phenomenon. The roaring market for assets from stocks to bitcoin suggests investors are flush with cash and speculating that prices will keep rising. An influx of money into precious metals has started to reverse, showing how fast money can flow back out.

A big unknown is how the drive to cut carbon emissions shifts supply and demand for different commodities. Switching to cleaner sources of energy will likely turbocharge purchases of materials such as copper and nickel, bulls contend. Before those efforts choke off demand for gasoline and diesel, a dearth of investment in the oil industry could buoy crude prices, too.

For now, however, the oil market remains on life support from members of the Organization of the Petroleum Exporting Countries and Russia, which are holding millions of barrels of crude in the ground each day to bolster prices.

The production cuts and a recovery in demand in China and India have helped oil prices rebound since crashing last spring. Brent crude futures have gained a third this year to about $69 a barrel. Some investors are betting they could surpass their all-time high of $148 a barrel in 2008.

U.S. production won’t keep up with the recovery in consumption due to restrictions on drilling on federal lands and belt-tightening by producers, said Christyan Malek, head of oil and gas research at JPMorgan Chase & Co. Cutting emissions at wells will boost production costs, and big oil companies are investing in renewable-energy sources instead of crude, he added.

The world’s biggest independent oil trader doesn’t see an imminent supply crunch. “We have plenty of reserves in the ground, we have plenty of refining capacity and we have plenty of ships to move oil,” said Giovanni Serio, head of research at Vitol.

Copper prices have leapt 67% over the past year to about $9,100 a metric ton on the London Metal Exchange. Goldman Sachs Group sees them hitting an all-time high of $10,500 in the next 12 months, in part because the energy transition will require metals that store and transmit power.

There are bumps in the road. Metal prices are the beneficiary of booming demand for goods and the economy’s emergence from lockdown. Both fillips are likely to fade. Also, it will be years before green infrastructure and technologies devour metals such as lithium at a pace that propels prices upward, analysts say.

Traders say there is plenty of copper available right now. Teck Resources Ltd., Ivanhoe Mines Ltd. and others, meanwhile, are due to start producing at new mines in the next few years.

The current run-up in metal prices in part reflects the same forces that have driven the past year’s recovery in stocks and corporate bonds.

“Fiscal and monetary stimulus has underpinned the rally since last March,” said Tom Mulqueen, head of research at Amalgamated Metal Trading Ltd. “There’s just more money in financial markets.”

Wall Street’s hottest trade has gone ice cold.

For years, it paid off to buy stocks that were rising in price—and bet against struggling shares. The momentum trade was especially profitable this year, as investors piled into hot stocks including Micron Technology, Nvidia, Advanced Micro Devices and other artificial-intelligence darlings while wagering against those likely to be hurt by the embrace of AI.

The S&P 500 Momentum Index soared 44% in the second quarter, its best quarterly performance on record, and it surged 133% over the past five years, nearly double the broad market’s performance.

Mega funds and rookie investors alike piled into the trade, some using leverage and options contracts in an effort to amplify their returns, propelling the underlying shares higher.

“It is a self-fulfilling prophecy,” said Matthew Tym, managing director at Cantor Fitzgerald, of the trade.

Suddenly, the trade is a loser. The momentum index has tumbled more than 9% since July 1, lagging behind the S&P 500’s 2.8% gain. The index—which tracks stocks in the S&P 500 based on a “momentum score”—is on track for the biggest quarterly underperformance in 25 years. July was the second-worst month for the momentum trade in around 40 years, according to Bank of America estimates; the only month worse was April 2009, in the teeth of the global financial crisis.

Hedge funds that bought momentum shares while shorting low-momentum stocks suffered even more. At the same time, a basket of the most popular stocks held by hedge funds tracked by Goldman Sachs recorded its biggest one-month underperformance in July relative to the S&P 500 in more than 20 years, according to the bank’s analysts.

Momentum trading is based on a rather simple observation: Investments that go up tend to keep outperforming; those that underperform often remain laggards. This kind of trading might seem too simple a stock-picking strategy to work. Yet it often has.

“For decades, it didn’t take a lot of sophistication to run a momentum strategy and make a decent living at it,” says Agustin Lebron, senior researcher at EquiLibre, a trading firm.

Part of the reason: It takes a while for corporate and other information to spread to various investors, so they slowly build positions, producing buying momentum.

“A huge pension fund can’t flip around its positions in a day,” says Lebron. “Behavioral biases also account for some of the effect, as well—people tend to sell their winners too early and hold losers too long.”

Fans of the strategy point to the human tendency to extrapolate from past results—and chase investment returns—noting that momentum patterns have been evident in markets for decades, even centuries. They also say that some of the worst months for momentum strategies are during longer periods of outperformance.

Some have been doing the trade by buying the strongest investments in a sector while shorting the weakest; others lean in to rising markets or asset classes. Still others use a quantitative approach or turn to banks or others who sell ways to make distinct wagers on momentum as a “tradable factor” or a “thematic basket.”

The fans remain believers. “Any strategy has disappointing periods,” says Antti Ilmanen, global co-head of the portfolio solutions group at AQR Capital Management.

The surge in Moderna and other biotech stocks helped crush the momentum trade. These shares were among the most heavily shorted in recent years, but positive news on a cancer vaccine from Moderna and Merck sent those stocks flying, crushing some quant and other hedge funds. Moderna is up around 150% so far this month.

These traders had an especially rough day on Aug. 19, which Goldman Sachs told its clients was the worst day for “systematic long-short managers” in more than two years. About half of the losses were because of momentum trades, the bank said.

Some traders have begun to short, or bet against, the very stocks that propelled the momentum trade earlier this year. Net short positions in futures tied to the Nasdaq-100 index among speculators recently climbed to some of the highest levels of the past two decades, according to data from the Commodity Futures Trading Commission.

The about-face is a sign of how markets have become more treacherous for investors, even as indexes keep climbing. Part of the issue: the recent meltdown of Situational Awareness, a hedge fund that had piled into some of the most popular momentum shares, including chip stocks. After a period of market tumult, Nvidia shares rocketed almost 9% after its earnings, showing how quickly sentiment can shift.

Some investors say the run-up in share prices driving tech stocks higher reminds them at times of the dot-com frenzy decades ago.

Mike Ogborne, the founder of San Francisco-based Ogborne Capital Management, said he has grown more cautious on technology stocks and is keeping more of his portfolio in cash than he typically does.

And he is nervous about the surge in spending by technology giants and quarterly capital expenditures that keep rising.

“It is a little bit like Cinderella and the clock striking midnight. You don’t know when midnight is going to come around,” Ogborne said. “They don’t send a memo around telling you when the capex cycle is over.”

Commodities Supercycle Looks Like A Stretch

Investors bet against history and predict a surge over extended period.

Wall Street’s hottest momentum trade has reversed sharply, as former winners tumble and heavily shorted stocks surge.