By John DePutter & Dave Milne – October 5, 2020
We have seen some commentaries and news stories lately about how cheap commodities are, compared with stocks. And with stocks running wild to the upside, that has naturally raised some questions about whether commodities might catch the same wave and fly higher.
Couple this with China’s massive purchases of soybeans and other commodities the past several months, and people are wondering if another macro-economic upswing might be in the cards – just like 2007 through 2008, which was followed by a second surge in 2011–2012 which brought even more markets to new all-time highs.
What it means:
The short answer is – another commodity boom is not likely. Admittedly, there are some drivers in place which might help, including the strong demand from China. But the full array of factors that contributed to the previous mega bull markets is simply not there. We would never say commodities do not have more upside room; a lot are cheap. But let us break down a few of the main reasons why we do not expect a repeat of those massive, towering markets of 2007–2008 and 2011–2012.
Weaker global economic conditions
During the 2008 through 2012 commodity boom, most countries around the world were enjoying strong economic growth. Indeed, it was not just China in the midst of an historic economic transition. Many other nations, including Indonesia, India, the US, Canada and Europe were growing strongly in terms of GDP. More people than ever were able to afford better diets, including more protein.
Those days are long gone. Amid a global pandemic, economic conditions are declining – in third world countries and highly industrialized, advanced economies alike.
The end of the ethanol revolution
Some of the fuel for corn’s run-up from $2 to $8 at the peak of 2012 came from demand for corn from ethanol plants. Crude took off to the upside at least a year before corn, providing a tip-off that corn could follow. With oil surging, it made sense to use cheap corn to make fuel. Ethanol plants sprang up across the US and other parts of the world. Crude oil at US$100 was a tremendous incentive to not only use more corn to make ethanol, but other biofuels as well. The corn market tore higher, helping lead other crop prices up in its wake.
The ethanol revolution is long past. Crude oil is cheap; it was worthless a few months ago and is still labouring around the $40 area. There is no natural incentive to use more corn for fuel.
Increased production capacity
Low prices and high interest rates during the 1980s and 90s offered little incentive for farmers and industry suppliers to boost productivity. Sure, yields kept improving, but there was little incentive for innovation. The boom that more recently brought higher prices and profits also brought new money, new interest, new ideas and new technology. The result is higher yields and greater production. Any time higher prices encourage more acres and more production, farmers tend to meet the call and spoil the opportunity for a massive bull market.
Genetics, agronomic knowledge, data management and various other factors represent a veritable revolution. These factors have enabled unprecedented capability. Farmers can quite simply produce more per acre than ever before. There is no end in sight to these gains. Farmers can, and will, respond quickly to shortfalls.
Rising South American output
One reason corn and soybean prices flew through the roof in those big money years was that the US was responsible for a large portion of global corn and soybean production. Now, South America has become a bigger player. In the past three years, combined Brazilian and Argentine production has accounted for about 13% of global corn output and almost half (48%) of the world’s soybean production. Granted, there are problems: Argentina is an economic basket case. Brazil is suffering just as badly from its own form of political unrest and instability. Both face weather threats this year. For the time being, Brazil is pretty much sold out of soybeans. But the primary trend in the background is up, as South American yields and export infrastructure are generally improving.
Prices in Brazil are near-record high in terms of the local currency, providing the incentive for even more production in 2020-21. There is more capability on that continent than there was 8 to 12 years ago, during the previous boom.
On the other hand . . .
In the world of commodity markets, you just never know. As we have outlined above, there are plenty of reasons why we should not expect another upside explosion in prices. Some wildcards do remain, not the least of which is the weather.
In 2012, the icing on the cake was one of the worst droughts in over 60 years. The so-called derecho that blew through parts of the Midwest earlier this year was another reminder that Mother Nature can never be taken for granted. Even today, with the amazing capability of farmers, the weather is still the biggest crop-price influencer. A severe weather problem in one or two major growing areas of the world could instantly alter the supply-demand balance for corn, soybeans and wheat.
The US dollar is a factor as well. As some will remember, the US Dollar Index, which measures the American currency against a basket of other major currencies, bottomed in April 2008 when commodities topped the first big up-wave. The index was weak again, not coincidentally, in 2011, helping drive US futures to their secondary peak in 2012. The greenback is not nearly as weak today, but a sudden downswing caused by unforeseen global geo-political events is always possible.
How the COVID-19 pandemic plays out is another factor to keep on eye on. Large populations must be fed. Production and supply lines outside of the developed world are severely compromised. Led by China, we are experiencing a wave of demand at this time. It could turn out to be more than just temporary.
We do not have all the same stars aligning for an upside breakthrough to new all-time highs by commodities. The same tripling or quadrupling of prices that happened in 2007-2008 and 2011-2012 is probably not in the cards.
Keep in touch. This could change. We’ll be monitoring the global factors and indicators closely in the months ahead.
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