Commodities are an asset class that can be thought of from various different perspectives: 1) Currency alternatives Throughout various times in history national currencies have been commodity-backed. Commodities have also served as means of payment money in themselves. 2) Store-holds of wealth Commodities are tangible and serve as assets that can be owned outside of the financial system. 3) Subject to specific supply and demand considerations Involves projecting out what kind of demand is there is for the commodity, sources of supply, how much of it is currently available, and how much is likely to be available in the future. For more on how and why commodities move in self-reinforcing cycles, more information can be found in the section below this one. 4) Subject to broader growth patterns Many, but not all, commodities correlate with global growth because they serve as inputs into finished goods. A slowdown in production means reduced demand for them. It depends on the commodity. Oil is more growth sensitive, for example, than sugar and its price is much more influential on other broader elements impacting asset prices, like inflation. 5) Contingent on global liquidity and inflation-adjusted interest rates Businesses, on aggregate, will invest more when interest rates are low, particularly of the inflation-adjusted variety because borrowing below an expected hurdle rate is more likely to increase the profitability of any given project. This increases demand for commodities and industrial inputs and increases their prices, holding all else equal. Central banks, on aggregate, are pulling back on liquidity. This is a headwind for commodities, ceteris paribus. However, commodities are still largely under-owned in portfolios and each commodity is subject to its own particular cycle even if they’re all intertwined in the broader market cycle. ___ How Commodities Move in Cycles Commodities trade in a five-phase cycle (sometimes condensed into four). Some cycles for certain commodities are faster or shorter than others and have different magnitudes in their peaks and troughs, but the general idea holds. 1. Demand exceeds supply: In this stage, capital investment into production is low. Accordingly, the amount coming online is also low. Due to a surge in demand from economic growth, innovation, new industrial usage(s), and/or investor speculation, demand exceeds supply and prices begin to rise from their bottom. 2. Production capex heats up: Due to a rise in demand, this incentivizes producers to invest more in production to meet this demand. Producers’ margins expand (or have the capacity to expand) as prices rise. Mining, exploration, and/or production activities become more profitable. This helps to boost growth and inflation in the broader economy. 3. Demand meet supply: Capacity increases and supply is put onto the market. Higher prices begin to undermine market demand. In turn, this encourages substitution (e.g., higher coal prices encouraging substitution toward natural gas; cobalt for lithium). Prices begin to stabilize. 4. Production tops demand: Higher investment and capacity eventually causes supply to exceed demand, putting downward pressure on prices. 5. Capex is slashed: Once the market is flooded with supply and prices begin to trek downward, producers will cut back on their investment or even discontinue it altogether if it’s unprofitable. This reduces capacity, supply begins to drain from the market, and prices decrease further until supply gets back in equilibrium with demand. Price speculation often causes the market to temporarily overshoot this bottom (the same is true with regard to tops in stage III). The cycle then turns back to stage one and repeats. ___ Commodities: 12-24 Month Outlook Bullish - Lead - Nickel - Chrome - Lumber Up then Down/Stable - Met coal - Zinc (fast cycle relative to other commodities) - Oil Neutral - Iron ore - Tin - Silver - Platinum - Uranium (very slow cycle + mostly private deals) - Steel Down then Up/Stable - Copper - Aluminum - Bauxite Bearish - Cobalt - Lithium - Palladium - Thermal coal - Natural gas - Liquefied natural gas - Manganese - Alumina ___ Conclusion Early 2016 was a once-in-a-generation opportunity where many commodities were at or near the very bottom of their cycles. They had gone into severe states of oversupply and were well below their costs of production. Nearly three years later there is far more dispersion in terms of what’s cheap, what’s expensive, and what’s priced appropriately.