In the 19th century, Great Britain was the superpower of the day. She was an empire with colonies, commercial interests and trading posts all over the world. Her navy was unrivalled, patrolling the world’s seas. Her currency, the Pound Sterling, was much of the world’s primary reserve currency during the 18th and 19th century.
The 20th century saw the secular decline of the British Empire. Two world wars and economic weakness resulted in the Pound Sterling losing the reserve currency status. At the same time, the 20th century saw the secular rise of the United States into an arguably, empire.
It has been said that today’s 21st century will see the secular rise of China. During the 20th century, China endured non-stop revolutions, civil wars, invasions, social upheavals, ideological experiments (e.g. Cultural Revolution, Great Leap Forward). It was the last couple of decades of the 20th century that China began to slowly emerge from her self-imposed shackles to catch up with the West. Napoleon once said that China is a sleeping giant that will shake the world when awaken. Today, despite the breakneck growth of the Chinese economy, China still have a lot of catching up to do in order to attain the same level of affluence, standard of living as the West- there are still hundreds of millions of peasants in China that is still relatively poor by Western standards.
Now, take a look at the United States today. With only a few hundred million people, the US consumes more oil than any other country in the world. China, with four times the population of the US, still does not consume as much natural resources as the US. What if China is to attain the same level of affluence and standard of living as the US? Imagine the amount of natural resources that will be consumed! We are not even sure whether the earth has enough resources to accommodate a nation that is equivalent to four United States in terms of population.
At this point, we still have not yet included Russia, Eastern Europe and India into the picture. Assuming that all these nations are to rise towards the level of the West as China is doing right now, imagine the strain their demands will be imposed on Mother Earth!
It has been said that demand for commodities follow a cyclical pattern. During recessions, the demand for commodities decline and during booms, demand rises. For example, copper is nicknamed the metal with ‘PhD in economics.’ The demand for copper is said to follow the business cycle.
Then there are people like Jimmy Rogers who believe that commodities are now in a upward super-cycle. Of course, there are sceptics to this super-cycle theory because of their underlying conviction that commodity demand still follows a cyclical trend. But what is the underlying belief of the commodity super-cycle theory?
Armed with the understanding from our previous article, Understanding secular vs cyclical, you can see that the rise of China (and India, Russia, etc) that we just described is a secular trend. Thus, the demand for commodities that supports this secular trend must also follow a secular trend too.
But does that automatically mean that commodity prices will go up and up for ever and ever for a very long period of time? From the short-term bubble in metal prices in 2006, it is obvious that there are many speculators who misapplied the commodity super-cycle theory to the extreme. For example, copper prices climbed so rapidly in the short-term that by mid-2006, after having risen in a parabolic path, its prices suffered a major correction.
Now, cast your eyes back to the 1930s in the US. With hindsight, we can easily see that the Great Depression was a traumatic setback in the secular rise of the US in the 20th century. But in the end, the US survived and went on to become a world superpower. The same goes for China. Although we believe China may be facing a major correction down the years (see Can China really ?de-couple? from a US recession?), it does not necessarily mean that her secular rise in the 21st century will come to an end, unless something really drastic happens to plunge China back into the dark ages of the 20th century. As such, her demand commodities will always rise in the long run. The best phrase that explains this point is from our previous article, Understanding secular vs cyclical:
Sometimes, within a larger secular trend, there are cyclical sub-trends.
As long-term investors, we should not lose sight of this big picture. Sure, commodity prices can even correct 50% in the short to medium term, but do not let the cyclical sub-trends cloud your understanding of the underlying secular trend.