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Economy

What goes up, must come down says professor David Jacks

BANGKOK -- We have now experienced a third commodity supercycle in 100 years, but it seems we have "reached the very peak." This is how David Jacks, economics professor at Simon Fraser University in Canada, explains the current commodities market, based on his analysis of price data for 40 commodities over 164 years.

Q: What is happening in the commodities market now, according to your research?

A: What is happening now, it seems, is that it is at the ending of high prices that we observed over the past 10 to 15 years, especially in the past five years.

     Commodity prices in the long run reflect the underlying scarcity and fact that we live in a place with finite resources. Over time, we use up most accessible natural resources, such as copper closest to the ground [and] petroleum that is easily drilled and piped out.

     In the medium run of one to three decades, there is a cyclical behavior where prices could go above or below [the] long-term trend. These [deviations] come from demand shocks. The most recent demand shock is coming from East Asia, China in particular. China really took off from [the] late 1990s or early 2000s as it has gone through [the] massive process of industrialization and urbanization. The problem is supply in the short run is fixed. We only have a certain number of oil wells, copper mines and steel mills. This translates into high prices. This is Economics 101.

     However in the course of [a] few years or a decade or two, there will be a supply response. Basically high prices induce technological innovations and exploration of new resources. Eventually, supply catches up with demand, and the prices start to ease back down. What we are seeing now is supply response coming into fruition. We had [a] tremendous capacity increase of iron ore, copper and petroleum. ... The nature of [the] commodity market being highly volatile, we could expect some overshooting. Prices may go beneath the trend line and witness some pretty significant further decline in real commodity prices.

Q: How would you place the shale gas revolution in this picture?

A: It is a classic example in a way. No one could have predicted the particular form that it will take, but the very high commodity prices, in this case petroleum, provided the incentive for innovators and investors to come up with [the] means to supply the market.

Q: Brazil's Vale, the world's largest iron ore producer, has just begun operating a big distribution facility in Malaysia to better serve its Chinese and Asian customers.

A: It is not only Vale, but Rio Tinto and BHP Billiton are also massively increasing production in West Australia. It is also a story of [a] lack of coordination across big producers. All of them are trying to be the first to get new supply online and be the first to sign these long-term contracts. But there is going to be someone to be the last. Vale's Malaysian enterprise might be one of the latecomers.

Q: You define a commodity price supercycle as "decades-long positive deviations from these long-run trends." Is this round over?

A: A historical comparison suggests it would probably be coming to the end of this upswing, having reached the very peak.

Q: Then in retrospect, when was the peak of this supercycle?

A: Looking at the evidence that I have, it would be around 2011 to 2014, depending how you want to define it. If you just want to look at peak pricing, it will be 2011.

Q: And this is the third supercycle according to your study?

A: Yes. One was in the early 20th century. America was going through very heavy industrialization and urbanization. And World War I was a boost to commodity demands, such as copper, steel, and agricultural products to feed the [armies].

     The second was in the 1960s to 1970s. Everyone has in mind the oil price shocks of 1973 and 1979, but commodity prices were rising across the board before that. Really significant reindustrialization and reurbanization were happening in Western Europe and Japan.

Q: Isn't it possible to have further demand shocks from countries like India and Indonesia?

A: I see the possibility from Indonesia in particular, and you may throw in Nigeria as another potential candidate there, but I don't see them emerging as a possibility anytime soon. India will be a sufficiently large demand shock to rival that of China, but I see it as fundamentally different from China. I don't see India really [going] through the transition China was able to achieve. There are still too many barriers to industrialization and urbanization put up by the government and by labor unions.

Q: Now that the third supercycle is approaching the end as you say, what will happen next?

A: It's a hard one. You will see more near-term weaknesses in commodity prices. I think still we have some potential downward trajectory. Why that is going to be interesting is because of the implication commodity prices at current levels or at slightly lower levels will have for exporter countries, such as Australia and Canada, versus importers, like Japan, Western Europe, and the U.S. There will be pretty interesting developments on that front.

Interviewed by Nikkei deputy editor Kenji Kawase

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