Stock and Commodity Cycles

Stocks and commodities have historically moved in opposite directions. Each asset class typically has a 16-18 year bull market followed by an equally long bear market. 

Being aware of these cycle patterns and understanding where in the cycle you are will give you great insight. Long term investors attempt to buy into these long bull market cycles early and ride them out until the end.

You don’t have to be a genius to make money in a bull market. Simply buying an index can give you great return in bull market cycle. The bull and bear stock market, commodity cycle shows remarkable consistency with a bull market in stocks and commodities taking turns every 16-18 years on average.

Each cycle during the 20th century has displayed similar characteristics.

1906 – 1923.
The commodity bull market began just before the stock market crash of 1907. This Crash was known as the “Bankers Crash” or the “Panic of 1907” and the New York Stcok Exchange fell 50%. The commodity bull market lasted until after WWI.  Characteristics to note are a stock market crash followed by a commodity bull market.

1929 – 1949.
In 1929 the stock market crashed. The Great Crash as it is known sent the Dow Jones Industrial Average from 380 in 1929 to 40 in 1932. Between 1929 and 1932 the Dow fell 90%.  During this time commodities were in a bull market and stocks were in a bear market. The bull market in commodities intensified during World War II.

1950 – 1965.
In 1950 the 2nd world war was over and the Great Depression had ended. A bull market in stocks lasted for the next 15 years.  Commodities were plentiful as production was still at very high levels.

1966 – 1982.
This bear market was notable for the market trading sideways for 16 years. The market fell 22% during this period and in comparison to past bear markets it doesn’t seem much but the real problem was inflation. The CPI in the U.S. increased by over 200% and interest rates reached double digits. Commodities boomed. There were a few stock market bear market rallies over this time but by 1982 no-one wanted to touch stocks, yet they were historically cheap.

1982 – 2000.
The cycle repeated again with an attack on inflation as central banks around the world raised interest rates.  The 1980’s recessions in the U.S. and Japan were short but deep and both countries exited the recession early, although Japan experienced a deep recession in the early 1990’s. The U.S. had to deal with the Savings and Loan crisis during the early 80’s as well. In 1982 growth in stock prices and the economy took off for the next 18 years.  This bull market ended with a .com mania, the “Tech Wreck’ and a crash in 2000. A bull market in commodities followed.

2000 – present.
The new commodity bull market started in 2000 with a sharp rebound in demand from emerging markets and particularly China. We don’t know when this commodities bull market will end but we estimate around 2016-2018. By the end of the commodity bull market commodities will no longer be in shortage as higher prices stimulate production of both prime commodities and alternatives.

Bull markets in stocks generally end with a crash followed by a commodities boom. The cycle is loosely around 18 years from boom to bust.

The current commodity super-cycle can be dated back to 1999. The major commodity indexes all hit their 20 year lows that year or in late 1998. Without doubt China and emerging market demand have been the drivers of the great commodity boom. Very low interest rates, thanks to the world’s central banks have made it attractive to own commodities in anticipation of inflation down the track.

Riding the commodity dragon with cheap money has been the name of the game.

China’s latest number are sobering, there has been a mark down in growth and trade partly caused by domestic policy changes but also because of weakness in Europe. Recent comments from BHP and Rio Tinto confirm a slowing of forward orders.

If China is slowing, and we expect it is, the question is one of term, or how long for? We don’t know, and neither does anyone else, we have to watch the numbers as they are released.

If commodity demand is softening what about the other factor, that of interest rates.

Federal Reserve Chairman Ben Bernanke is famous for having said that the Fed expects that abnormally low interest rates should start rising in late 2014. But fed funds futures indicate rates will rise sooner than that, perhaps as early as mid to late 2013.

As we have listed above, there have been three periods in the past 80 years where periods of ultra-loose US monetary policy have coincided with upswings in the commodity-price cycle. These were the 1930s to the 1940s, the late 1960s to the 1970s, and the current period beginning in 1999.

As we noted earlier commodity cycles, tend to coincide with equity bear markets and last between 15 and 25 years. The current commodity cycle could run out of steam as early as 2014, bearing in mind that cycles are not an exact science.

One thing we expect is that commodity prices will have turned down well before official recognition of changes in underlying supply and demand for raw materials.