Perhaps one of the most misunderstood things in the investing universe is the commodities supercycle. Basically, commodity prices rise over 17 years, then fall over the next 17 years, and then increase again. These commodity bull and bear markets alternate with stocks and share bull and bear markets.
Yet while it is commonly accepted that these cycles occur with stock markets, people seem to find it difficult to accept that the same process occurs with oil, iron ore, copper and corn.
A time of soaring profits…
At the beginning of the cycle commodity supply is low, while demand is high; this causes commodity price inflation. Manufacturers raise prices to maintain their margins, consumers economise, their spending falls, and stock markets fall.
During this time of high commodity prices, the more oil and iron ore you produce, the more you will sell. So the oil majors and the miners invest heavily in exploration and production. These companies’ profits soar, along with their share prices, as investors flock to commodities. You hardly need me to say that this is the time to invest in resources companies.
As this process continues, commodities supply has been increased vastly. Miners such as Rio Tinto (LSE: RIO) and BHP Billiton (LSE: BLT) have been pouring money into mining developments around the world, companies such as BP are drilling oil wells in the far reaches of the Arctic, and all-the-while US shale oil producers are ramping up production. At the same time, consumers have begun to reduce their dependence on these highly-priced commodities, and there is much talk of a world-wide resource shortage. They buy fuel-efficient, hybrid and electric vehicles. And demand tumbles.
So of course you know what happens next.
…followed by a time of sliding share prices
The oil price has been tumbling recently, but you might be surprised to hear that the price of iron ore has fallen even further over the past year. Just as I have said that oil company profits are likely to slide, along with their share prices, I expect the same thing will happen with Rio Tinto and BHP Billiton. Just as it is likely that investment in new oil production will fall, so will investment in metals and minerals production, as supply has to adjust to falling demand.
At the trough of the commodities bear market in the late 1990s the share price of BHP Billiton fell to 112p; it now stands at 1369p, having reached as high as 2551p. Just as I think it is time to sell oil company shares, I think it is time to sell Rio Tinto and BHP Billiton, too.