Why the Resource ‘Super-Cycle’ is Still Intact

I believe we are still in a resource ‘super-cycle’ — a long period of increasing commodity prices in both nominal and real terms.

The market conditions of the past two years have made many observers doubt this assertion. But I believe the current cyclical decline is a normal and healthy part of the ongoing secular bull market.

The most striking analogy to the current situation occurred in the epic gold bull market in the 1970s. You may recall that gold prices advanced from US$35 per ounce to $850 per ounce over the course of that decade.

You may also recall that, in 1975 and 1976, a cyclical decline saw the price of gold decline by 50% — from about $200 per ounce down to about $100 per ounce. It then rebounded over the next six years to $850 per ounce.

Investors who lacked the conviction to maintain their positions missed an 850% move over six short years. The current gold bull market, since its inception in 2000, has experienced eight declines of 10% or greater, and three declines, including the present one, of more than 20%.

This volatility need not threaten the investor that has the intellectual and financial resources to exploit it.

The natural resources bull market lives

The ‘super-cycle’ is a direct result of several factors. The most important of these is, ironically, the deep resource bear markets that started in 1982 and lasted for almost two decades. This critically constrained investment in a capital-intensive industry where assets are depleted over time.

Productive capacity declined in every category; very little exploration took place; few new mines or oilfields replenished reserves; infrastructure and processing assets deteriorated. Critical human resource capabilities suffered as well; as workers retired or got laid off, replacements were neither trained nor hired.

National Oil Companies (NOCs) exacerbated this decline in many nations by milking their oil and gas industries to subsidize domestic spending programs for political gain.

This was done at the expense of sustaining capital investments. The worst examples are Mexico, Venezuela, Ecuador, Peru, Indonesia and Iran. I believe 25% of world export crude capacity may be at risk from failure of NOCs to maintain and expand their productive assets.

Demands for social contributions in the form of taxes, royalties, carried equity interests, social or infrastructure contributions and the like have increased. Voters are not concerned that producers need real returns to recover from two decades of under-investment, or to fund capital investments to offset depletion.

Today this is actively constraining investment, and hence supply.

Poor people are getting richer…

The super-cycle is also driven by globalization and the social and political liberalization of emerging and frontier markets. As people become freer, they tend to become richer.

As poor countries become less poor, their purchases tend to be very commodity-centric, especially compared to Western consumers. For the 3.5 billion people at the bottom of the economic pyramid, the goods that provide the most utility are material goods and consumables, rather than the information services or ‘high value-added’ goods.

A poor or very poor household is likely to increase its aggregate calorie consumption — both by eating more food and more energy-dense food like meat. They will likely consume more electrical power and motor fuel and upgrade their home from adobe or thatch to higher-quality building materials.

As people’s incomes increase in developing and frontier markets, the goods they buy are commodity-intensive, which drives up demand per capita. And we are talking billions of ‘capitas’.

Rising incomes and savings among certain cultures in the Middle East, South Asia, and East Asia — places with a strong cultural affinity for bullion — have increased the demand for gold, silver, platinum, and palladium bullion.

Bullion has been a store of value in these regions for generations, and rising incomes have generated physical bullion demand that has surprised many Western-centric analysts.

Competitive devaluation

The third important driver in this cycle has been the depreciation of currencies and the impact that has had on nominal pricing for resources and precious metals.

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