What if commodity prices are low for 15 years?

Following our analysis of the super commodity cycle and the conclusion that commodity prices should stay low or continue to fall for the next 15 years, this article looks at the future.

It looks likely that the recent fall in commodity prices may be one of the biggest ever on record. The fall may even match the 66% implosion experienced between 1917 and 1931.

One fact in every supper commodity cycle is that every rise in commodity prices is followed by oversupply. This oversupply continues for years as companies battle it out in a dangerous game of survival to cut production and costs.

Remember the oil crisis in the 1970s? The current oil price is lower than it was in 1981 as there is just too much oil production. Oil producers are still pumping like crazy to maintain “market share” and their biggest enemy is other oil producers, not their customers. Witness the warm feeling Iran has towards the West and Saudi Arabia proxy wars on Iran.

Do you remember the shortages of steel, iron ore and a host of other materials such as lumber and rubber? Neither does the rest of the world. In the case of steel, depressed prices flow from massive overproduction of the magnitude that the world can rebuild its infrastructure over the next decade with the current iron ore supply.

Steel prices have also not hit rock bottom yet as more supply is on the way and iron ore prices have fallen by two thirds.

Consumers, on the other hand, have fat years ahead of them as the prices of wheat, corn, oats and meat are at their lowest levels ever in real terms – the cheapest in real terms. We have more than 750 years of wheat price data and it shows that wheat prices at the end of 2015 were in fact 6% cheaper than at the end of 1973 in nominal dollar terms.

Simply put, the world has too much food such as maize and wheat. Beef and chicken prices are dropping in USD terms too. I guess that by the end of the low commodity cycle consumers in advanced countries will spend less than 5% of income on food and in some cases more on eating out.

The effects on emerging market economies like South Africa will be huge if history repeats itself and the world enters a period of another 15 years of low prices for our commodity exports. That takes us back to when we had to watch the current account balance like hawks.

I will stick my neck out and make the prediction that most of the falls are behind us, but commodity prices have another 30% to fall from in real terms but it could be that prices must fall another 20% before we hit rock bottom.

The world changes in this part of the cycle.

Remember the hyper or high inflation in Germany in the 1920s and ’30s and the depressed prices in places such as the US and the UK at the time?

Something similar is happening today. Brazil and Russia have double-digit inflation and Venezuela may have inflation higher than 100%.

Growth in Europe and the US is picking up but many have deflation such as Switzerland or very low inflation such as the Eurozone and the US. Japan too has very low inflation.

The realignment of currencies is probably the biggest difference between the Great Depression world and current weak growth. Currencies are acting as buffers for commodity exports and as further deflationary anchors for the developed world and China.

Rising unemployment in Brazil, Russia, Saudi Arabia and of course Africa will also have significant political implications. Add the lower growth outlook to the Middle East and Africa and those two continents will again start falling back along with much of Latin America. This in turn will allow increased inequality between rich and poor countries.

Not only will these countries suffer lower income from commodities but their interest rates and inflation will be higher. The impact will also be visible in their current account and government fiscal balances will remain under pressure.

Just like any perfect storm these countries will also see ratings downgrades. Generally these are the parts of the world where population growth is still higher than the average and that also indicates that the richer world will see migration from these countries continue.

This will not be a once off situation but will continue well into the first part of the next commodity upswing so expect Europe and North America to continue to see high numbers of refugees and migrants. Perhaps Japan, China and Thailand will also see migration to their countries.

This will continue well into the 2030s and will have big impacts on housing; religion and social cohesion in the receiving countries. The brain drain of the developing world will unfortunately continue but over time tourism and remittances will grow strongly as well as some exports of local favourites (Mrs Balls Chutney comes to mind.)

The big man syndrome along with Dutch disease will be off the radar for the next two decades and poor countries will get out of mining and other services to mining. We will see privatisation make a very big comeback in most African and Middle Eastern countries as budget holes enforce sales. Africa will become much more of a friendly investment destination as countries implore companies to invest.

The rich world will evolve into the next evolution in economic terms with renewable energy, energy storage and new services. Countries who are dependant on commodity exports will have to find new ways to attract wealth and to create jobs. It will have to change to allow for the delivery of more value-added services such as tourism, call centres and probably even high-end personal services to the richer world.

Commodity companies will change

Importantly however is that another 15 years of low commodity prices would also ensure the metamorphoses of commodity and agriculture companies.

These companies will employ fewer workers and will become much more mechanised and automated.

The companies will grow larger and larger to make use of economies of scale and they will innovate to develop new mining methods and concentrate their effort in countries where barriers to operations are lower. They will become more important for commodity countries to attract and that will be their main strength for the next two decades. The bigger companies will take over state-owned companies and increase productivity and bring modern management methods to play.

Agriculture will also go big and in contrast to the mining sector, there will be room for small niche farms such as the production of organic produce.

The small farmer will be the specialist, the generalist will be massive!

 Look out for the next article on the low commodity price effect on South Africa.