Commodities And The Boom-Bust Cycle

It is always interesting when commodity prices rise. The market produces various narratives to suggest why prices will keep growing indefinitely. Such applies to all commodities, from oil to orange juice or cocoa beans. For example, Michael Hartnett of BofA recently noted:

The 40-year period from 1980 to 2020 was the era of disinflation: thanks to fiscal discipline, globalization, and peace, markets saw ‘deflation assets’ (government and corporate bonds, S&P, growth stocks) outperform ‘inflation assets’ (cash, commodities, TIPS, EAFE, banks, value). As shown below, ‘deflation’ annualized 10% vs. 8% for ‘inflation’ over the 40-year period.

But the regime change of the past 4 years has roles reversed, and now ‘magnificent’ inflation assets are annualizing 11% returns vs 7% for deflation assets.”

Mind you, this is not the first time that markets have gone “cuckoo for commodities.” The most recent episode in 2007 was “Peak Oil.” However, crucially, this time is never different. As shown below, commodities regularly have surges in performance and are the best-performing asset class in a given year or two. Then, that performance reverses sharply to the worst-performing asset class.

That performance “boom and bust” has remained since the 1970s. The chart below shows the Commodities Index’s performance over the last 50 years. On a buy-and-hold basis, investors received a 40% total return on their investment. This is because, along the way, there were fantastic rallies in commodities followed by huge busts.

Such brings us to the big question? Why do commodities regularly boom and bust?

Why Do Commodities Boom And Bust

The problem with the idea of a structural shift to commodities in the future and why it hasn’t happened in the past is due to the drivers of commodity prices.

Here is a simplistic example.

  • During a commodity cycle, the initial phase of a commodity
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