Commodity Cycle

The commodity cycle is the pattern of long rises and falls in the prices of raw materials such as oil, metals and crops. High prices encourage producers to invest in new mines, wells and farmland; because that supply takes years to arrive, it often lands just as demand cools, pushing prices down until investment dries up and the next shortage begins. The cycle is a version of boom and bust specific to commodity markets.

Cycles vary in length. Short swings of a year or two follow weather, inventories and the business cycle; much longer waves lasting a decade or more are called "supercycles" and are usually linked to the industrialization of a large economy. The cycle matters for investors, for central banks fighting inflation and above all for countries that depend on exporting commodities.

Imagine a town where everyone suddenly wants fresh eggs. Egg prices jump, so lots of people buy hens. But hens take months to start laying. By the time they do, the craze has cooled, the shops are full of eggs and prices crash. Many give up their hens, and a year later eggs are scarce again.

Oil fields and copper mines are like those hens, only they take five or ten years to bring into production and cost billions. That long delay is why commodity prices tend to overshoot in both directions rather than settling gently.

• Slow supply response. Supply is inelastic in the short run. A new mine can take a decade from discovery to output, so supply reacts to price with a long lag.
• Price-insensitive demand. Demand for fuel and food is also fairly inelastic, so small shortfalls cause large price moves.
• Global growth. Construction, manufacturing and transport use huge amounts of energy and metals, so world growth and especially the industrialization of emerging markets set the long trend.
• The dollar and interest rates. Most commodities are priced in US dollars. A stronger dollar tends to weigh on prices, and higher interest rates raise the cost of holding stocks.
• Policy and producer behavior. Output decisions by the Organization of the Petroleum Exporting Countries (OPEC) and its partners, export bans, sanctions and wars can tighten or loosen supply suddenly.
• Financial flows. Investment funds and speculation can amplify moves once a trend is under way, although economists disagree on how much they change long-term prices.

Economists usually identify several broad price waves since the late nineteenth century, linked to US industrialization, post-war reconstruction in Europe and Japan, and the 1970s oil shocks. The most recent supercycle began in the early 2000s, when China's rapid growth drove demand for iron ore, copper, coal and oil. Oil prices peaked at close to $150 a barrel in July 2008 before collapsing in the global financial crisis, then recovered as China's stimulus revived demand.

That wave ended in 2014 to 2016. Years of high prices had funded new supply, including the US shale oil boom, while Chinese growth slowed; oil fell from over $100 a barrel in mid-2014 to below $30 in early 2016, and metal prices dropped sharply. In April 2020, pandemic lockdowns briefly sent the expiring US crude futures contract below zero. Prices then rebounded on recovery and the 2022 war in Ukraine, which pushed energy and grain prices to multi-year highs before they eased. Whether the energy transition will start a new supercycle in metals such as copper and lithium is an open debate.

For exporters, the cycle drives the terms of trade, government revenue and the exchange rate. Booms bring investment and strong currencies but can crowd out other industries, a pattern known as "Dutch disease" and linked to the resource curse. Busts can bring budget crises, currency falls and, in severe cases, sovereign default. Many economists recommend counter-cyclical fiscal rules and saving windfalls in a sovereign wealth fund, as Norway and Chile do in different ways.

For importers, high prices act like a tax on consumers and a supply shock to firms, raising inflation and slowing growth. Central banks must judge whether a commodity spike will fade or spread into wages and other prices through a wage-price spiral.

Analysts watch inventories, capital spending by producers, the shape of the futures curve and broad price indices published by the World Bank and the IMF. A futures curve in steep backwardation usually signals tight supply; a deep contango signals a glut. Because cycles are long and their turning points hard to time, many investors use commodity exposure mainly for diversification and as a partial hedge against inflation rather than as a timing bet.

• World Bank: Commodity Markets Outlook
• International Monetary Fund: Primary Commodity Prices