The vaccination process against covid-19, which is accelerating especially in developed countries with the United States and the United Kingdom in the lead, is allowing the recovery of the global economy. Logically, the expansionary monetary policy and the fiscal emergency packages approved by the main economies are the turboprop of this recovery. But there are opinions that so much “power in the turbo” is not needed because the increase in activity, plus the accelerating effect of fiscal and monetary policies, and the removal of mobility restrictions will generate inflationary pressures that force limit growth.
The biggest inflation revisions are in the US, where stimuli are being higher. At the moment, there is still a lot of room for improvement in the weakened labor market. However, the US consumer price index (CPI) is rebounding to record highs. Logically, this rise is partly explained by the base effect after the fall in prices last year. However, decomposing this index and analyzing it we see that much of this rebound is explained by energy and food prices. Additionally, if we observe the evolution of the producer price index or wholesale prices (PPI), we find that it is situated at high levels and highly correlated with the raw material indices. Let us remember that the transmission mechanism of the increase in prices from the producer to the consumer is approximately six months.
The explanation for the increase in PPI is given only in part by the shortage of semiconductors and the interruption of supply chains due to difficulties in maritime transport, but the bulk of the increase derives from the evolution of the price of raw materials with the price of copper and oil in the lead. The latter has a cross-cutting effect on energy prices. The current rally in raw material prices is explained by the decrease in supply as a result of the pandemic, which is in contrast to the rapid recovery of industrial production and the drive of expansionary policies by governments and central banks. Without ruling out that investors are looking for assets to take more risk given the liquidity of the markets and the commodities they are an attractive investment asset, especially with high inflation.
The question emerges when it is analyzed whether this significant rebound in raw material prices is transitory, as a consequence of the reduction they experienced during the pandemic, or if we are facing a new raw material supercycle. Let us remember that the definition of a supercycle proposed by the United Nations is a sustained increase in the prices of raw materials above the growth trend of the economy and that it is driven by a structural change in demand. The last supercycle began with the incorporation of China as part of the World Trade Organization (WTO), which energized its industrialization process, promoted urbanization and even changed consumer habits in one of the most populated countries in the world. These solid real fundamentals were accompanied by investors who turned to invest in the most profitable asset of the decade.
But returning to the sustainability of this rebound in the prices of commodities, What we find in the short term is that the years in which the prices of raw materials were at a minimum did not stimulate investment, and this means that we are now facing markets in which demand will be greater than supply, which it translates into a reduction in your inventory level. This trend is not easy to reverse, since in the case of metals the investment cycle is three to four years.
But in the medium and long term we need a sustained increase in demand, in this sense the commitment of the countries to comply with the Paris Agreement is key. The process of decarbonization of the economy requires an increase in the demand for non-energy raw materials, especially metals.
The adoption of technologies that reduce CO2 emissions requires the use of more metals, such as copper and aluminum. To dispose of these metals it is necessary to stimulate a new investment cycle with remunerative prices.
The transition to clean energy requires the need to develop solar panels, turbines, electric vehicles and invest in the development of the electricity grid. In this sense, metals such as copper, nickel, lithium, cobalt and rare minerals will experience a strong increase in demand. The International Energy Agency (IEA) estimates that demand for minerals needed to meet net zero emissions targets will skyrocket over the next two decades. The transition of the energy sector will be responsible for 40% of the demand for copper, between 60% and 70% of the demand for nickel and cobalt, and 90% of the demand for lithium. Comparing with current consumption, we find that the demand for rare metals would multiply by seven, while that for lithium would increase 42 times.
In this sense, it is not surprising that in recent days the price of copper has exceeded $ 10,000 per ton. This metal is essential in the green industrial electricity transmission process, as it has few competitors. Additionally, the recent pandemic slowed down investment in key mining areas such as Latin America, considerably reducing prospecting for new deposits and lowering capex. [inversión en capital] in mining.
Low levels of investment in mining in recent years due to low prices have severely limited the production of raw materials. This situation and the rebound in demand sustain the upward trend in raw materials. In the future, the challenge of decarbonization of the world economy represents a tailwind for a new upward cycle of raw materials.
However, unlike past supercycles, there should be no sustained increases in demand for oil or natural gas, but we can also generate a sustained upward cycle of energy prices if we insist on cutting investment before we have cut back on energy. demand, which will push prices up, not only for energy, but also for other raw materials that require a lot of energy for their extraction or cultivation. That is why it is necessary to be very cautious with scenarios that require a reduction in supply without explaining how demand will be reduced.
Antonio Merino He is Director of Studies at Repsol.