We Hear Whispers of a Supercycle, but Is the Reflation Trade Capitulating?

Fiscal stimulus and soaring expectations of inflation have led to whispers of an impending commodity supercycle. In early 2021, at least one prominent bank even proclaimed we are at the dawn of a new commodity boom because of similar structural forces to those that drove commodities in the 2000s. But I believe there are some obstacles to that premise that cannot be ignored. First, the U.S. dollar is stronger now than it was during the commodity rally spanning from 2007 to 2012. During that time frame, the dollar index futures traded on the ICE Exchange hovered from $70.00 to $90.00. In the current environment, the dollar seems to be comfortably trading in a range between $90.00 and $105.00. This alone tapers the potential for rampant speculative rallies. Of course, if the dollar breaks below $89.00 and falls into the same trading range it experienced in the 2010s, a commodity supercycle is more probable. Second, the futures markets are more liquid, trade longer hours, and are more accessible to both speculators and hedgers. As a result, we are less likely to see the same caliber of dramatic price squeezes witnessed in previous commodity booms. In short, perhaps the commodity markets are slightly more civilized now than they have been in the past. For instance, some might remember wheat futures tripling in value before peaking near $13.00 per bushel in 2008, taking out some experienced traders, hedge funds, and even brokerages along the way. At the time, most retail traders were calling orders into a trading desk and didn't have access to live pricing on their computers, let alone their mobile devices. The absence of market accessibility and transparency undoubtedly added fuel to the emotional fire. Third, traders and investors have more access to timely information than they had during previous commodity supercycles. On previous occasions, the lack of real-time quotes and streaming headlines likely bred panic; in today's world, traders are more prone to be alarmed by an abundance of expedient information not a lack of it. And, fourth, improved technology has created far more efficient farms, mining operations, and energy extraction methods. Technological advances work against the severity and longevity of supply shortages because producers and end-users can be more flexible. Grains are renewable annually, a supply crunch in one growing cycle due to a bad hand dealt by Mother Nature can be rectified within one or two growing cycles as farmers adjust their plantings based on where they can obtain the highest priced product per acre. In energies, fracking has been a game-changer to the supply side of the equation. We have yet to see what political interference might do to that dynamic, but it is probably fair to say the peak oil concerns that persisted a decade ago probably aren't in the conversation at the moment. Source: QST So, it is too early to completely disregard the idea of an imminent commodity supercycle, but I am proceeding with the assumption that these fundamental conditions will prevent a repeat of the previous commodity boom. Further, it is worth noting that as oil was approaching $150 per barrel in 2008, the same bank calling for this to be the beginning of a commodity supercycle was convinced $200 crude oil was a near guarantee. In short, their cries of a super-cycle today could be a better contrarian indicator than a sign of a commodity boom. The other side of the reflation trade is collapsing Treasuries; as traders' fears of inflation flare up the selling in U.S. bonds and notes has accelerated. Yet, March is a month known for capitulation trades (think stocks in 2009 and again in 2020). Perhaps we are at the tail end of a bond market capitulation that could mark the low for months, or years, to come.

We Hear Whispers of a Supercycle, but Is the Reflation Trade Capitulating?

It is too early to completely disregard the idea of an imminent commodity supercycle, but I don't see a repeat of the previous commodity boom. Here's why.

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