Headwinds for the Industrial Materials Sector

The industrial commodity sector experienced a robust surge over the 20 years between 2002 and 2022. However, since January 2023 industrial commodities and derivatives have struggled: Copper, aluminum, zinc, and nickel declined 10%, 15%, 30%, and 45%, respectively. Particularly striking is the significant 80% downturn in lithium prices.

Decline in Prices of Base Metals

Those are not the only metals facing challenges; most other raw industrial materials are also on a similar downward trajectory. This prompts questions about whether the supercycle in this sector has come to an end.

Decline in Prices of the Entire Raw Industrial Materials Sector

Although numerous research reports exist on this topic (primarily focusing on the supply-demand dynamics of individual materials), this article takes a different approach: redirecting attention to the macroeconomic landscape.

Rather than delving into specific supply-demand intricacies, we inspect the historical price trends and cycles of industrial commodities over the past two centuries. By examining long-term patterns, we gain historical perspective that provides valuable context for understanding the current state of the industrial commodity sector.

The Centuries-Long Downward Trend: Industrial Materials

Over the span of two centuries (1800 – present), raw industrial material prices have risen remarkably: approximately 900%.

Long-Term Perspective: Nominal Price

However, when considering their real prices, an intriguing decline of 50% emerges.

Long-Term Perspective: Real Prices Between 1790 - Present

The trajectory of real prices over the 200-year span reveals two distinct phases.

Phase one. From 1790 to 1890, industrial real prices remained stable despite the advent of steam power, a remarkable achievement of the first industrial revolution. While the steam engine began to significantly influence the manufacturing industry, it needed time to penetrate the whole production line. Its impact on reducing the production cost of industrial raw materials was limited to about 100 years.

Phase two. From 1890 to present, raw industrial product prices experienced significant declines as a result of technological innovations such as electricity, automation, computing, and information dissemination. At the same time, the innovations:

• Enabled substantial increases in productivity across industries as workers produced physical goods more efficiently and in larger quantities.

• Fostered the growth of urban centers and facilitated the mass production of physical goods, resulting in additional economies of scale and boosts to productivity.

• Facilitated, in the more recent decades, the digital exchange of ideas, services, and data (e.g., collection, storage, analysis).

With the AI revolution, we foresee a continued downward trend in real prices over the long term. Thus, the trend of declining prices remains intact.

Historical Boom and Bust Cycles (1890-2002)

Long-term downward trends and significant investments in infrastructure have dissuaded some investors from allocating resources to the supply side. Consequently, supply constraints often arose when demand surged, resulting in classic commodity market supercycles. 

Therefore, compared to the downward price trend, investors are more interested in the long-term business cycles (next chart). Examining deviations between 1890 to 2002 reveals distinct long-term cycles. Price upswings or downswings typically span 10 to 20 years, respectively. The reasons for these upswings varies across factors such as post-war reconstruction, industrialization in emerging markets, globalization, or investment hedging, for example. However, one commonality persists: each of these factors has driven demand to soar.

For industrial commodities, the supply side consistently lags behind the demand side, inevitably leading to boom and bust cycles. The surge in prices prompts the supply side to increase investments to meet demand, initiating a boom. However, over time, the supply side faces a surplus, heralding the bust period.

Boom and Bust Cycles

The Current Cycle: 2002 - Present

Since 2002, the real price of raw industrial materials has increased significantly. Now, the 15-year moving average has reached a turning point: If history repeats itself, this suggests the period of booming prices may be coming to an end.

The predominant drivers of the current upswing cycle are globalization and industrialization in emerging markets, particularly China. With China having completed its industrialization phase and globalization encountering strong headwinds, a mean reversion in the real price of raw industrial materials seems likely.

This raises another question: Is an immediate decline likely in the near future? The answer is no, because demand is still growing slowly, and the supply side is not experiencing permanent and massive closures.

The clean energy revolution has spurred new demand on raw industrial materials. For example, the copper demand from EV, renewable energy, and green grid has continued to increase. In 2023, it accounted for around 15% of total consumption.

Emerging market countries other than China, such as India and Vietnam, have intensified their industrialization efforts, further boosting demand.

Moreover, commodities have low correlation with stocks and bonds, providing an option for portfolio diversification. The CRB Raw Industrial Growth Index has already hit a bottom and rebounded, suggesting that high inflation may persist for a while and could spur demand for commodities as a hedge in the short term.

CRB Price Index Has Bottomed

On the flip side, the share of total demand from the clean-energy sector remains relatively small. Additionally, India and Vietnam may not be capable of fully replacing China's role in the commodity market, as illustrated in the following chart. The inflation could finally ease.

India and Vietnam Can’t Replace China’s Role in the Short Term

Conclusion

The price trajectory of raw industrial materials indicates a sustained downward trend, leading to classic long-term, boom-bust supercycles. However, it's crucial to recognize that the business cycles of commodities are important for investors.

Historical patterns indicate that periods of upward momentum are often followed by downturns, underscoring the cyclical nature of commodity markets. As the current upswing has lasted for 20 years, it implies this supercycle is nearing its peak.

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