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Commodity price cycle looks increasingly mature: Kemp

By John Kemp

LONDON (Reuters) - Time is the most important variable in commodity markets but also the most frequently overlooked.

Too often observers become trapped in an endless short term and fail to notice that the world is gradually changing around them.

As is well known, in the short term both supply and demand for most commodities are fixed and show little response to small price changes

Lack of responsiveness in the short term is why very large price adjustments are required to force markets back into balance and why commodities exhibit more volatility than the prices of other goods and services.

In the long term, supply and demand become almost infinitely variable. Investors can develop new sources of supply, inefficient producers can close, consumers can change their behavior and alternatives to most raw materials can become available.

But the most interesting time-frame from an analytical point of view is the medium run, where the short term shades imperceptibly into the long term and where supply and demand are neither fully fixed nor yet completely flexible.

It is the medium run that has by far the most interesting price and technology dynamics as producers and consumers figure out whether to make expensive changes that may pay off only over many years or even decades.

PRICE-INVESTMENT CYCLES

In reality, commodity-market time is a continuum. The short run shades into the medium term and the medium run shades into the long run in an indistinct way that differs significantly from industry to industry.

For agricultural commodities, the most important distinction between the short run, the medium term and the long term is the length of the crop cycle, which varies from as little as a year for the grains such as corn, wheat and soy, to decades for new forests.

For minerals and petroleum, the cycle is determined by the time needed to identify new resources and alternative technologies, plan and finance major new capital projects and then build them, which ranges from five years to as much as 10 for a major new mine or offshore oil field.

Price cycles for industrial raw materials, therefore, tend to be deeper and longer than for faster-reacting farm products.

But even the most capital-intensive and slowest responding commodities do not remain stuck in the short run forever.

SUPER-CYCLE IS NOT THE END

In the past 10 years, industrial, energy and agricultural commodities have experienced the biggest and most synchronized upswing since the 1970s.

It is a shift that many analysts have dubbed the super-cycle, meaning that prices have been stronger for longer.

But the super-cycle that began around 2000 is still a cycle, as the name implies. The cyclical behavior of commodity markets, which is deeply rooted in their fundamentals, has not been repealed, only exaggerated this time around.

Prices may have risen higher and been sustained longer than in preceding cycles, but that does not mean they will remain near record peaks forever.

Prices for almost all major commodities peaked at some point between 2005 and 2012, ranging from U.S. natural gas (in 2005 and 2008), nickel (2007), crude (2008), aluminium (2008), wheat (2008), cocoa (2010), copper (2011), corn (2012) and soy (2012).

In most cases, however, prices are now well below their previous levels and the downward leg of the price cycle appears firmly established. More supply increases still to come will add to the downward pressure in the short term.

Even for slow-responding commodities such as oil, iron ore and rare-earth minerals, the current price cycle looks well past its peak.

Their supplies are now responding aggressively to the run-up in prices over the past decade, which was only briefly interrupted by the financial crisis in 2008 and 2009.

Demand is also starting to shift as consumers learn to cut their use of raw materials or find cheaper, more plentiful alternatives.

EVEN OIL MARKET HAS TURNED

In the crude market, which has been one of the slowest to react of all, prices have been on a broad upward trend for over 14 years. This month marks the fifth anniversary of their record peak in July 2008.

Relentless price rises have transformed the outlook for both oil production and consumption. Record investment resulted in the largest one-year jump in U.S. oil output last year, while the proliferation of biofuels and conservation measures has put consumption on a firm downward trend across North America and Europe.

Responding to earlier price rises, conservation measures approved in the 2005 Energy Policy Act and 2007 Energy Independence and Security Act are now beginning to curb petroleum demand in the United States.

Recently agreed vehicle efficiency standards promise continued reductions in gasoline and diesel consumption well into the 2020s in both the United States and the European Union.

Consumers have also started to experiment with using liquefied and compressed natural gas as an alternative fuel for trucks, ships and trains.

On the supply side, record prices have spurred the upsurge in drilling for shale oil in North America and record spending overseas on new conventional fields in deepwater as well as in frontier areas like the Arctic and central Africa.

Past experience suggests it takes five to 10 years for oil price changes to have their full impact on supply and demand. If so, industry and consumers have had plenty of time to make the necessary adjustments, which is evident in the growing flexibility on both demand and supply sides of the market.

(John Kemp is a Reuters market analyst. The views expressed are his own)

(editing by Jane Baird)

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