The ‘Super Cycle’ and Julian Simon
Simon wins the 2010s and the last 120 years
The commodity ‘super cycle’ is once again a major theme for markets. I never liked the term ‘super cycle,’ which Google helpfully defines as ‘decade-long periods in which commodities trade above their long-term price trend.’ So it’s just a long cycle then? The term is seemingly only ever applied to commodity markets (although the Elliott Wave people have their ‘grand super cycle’ in everything). There are well understood reasons why commodity prices undergo multi-year, if not multi-decade, cycles. Whereas commodity demand can turn on a dime, commodity supply is not so easily turned up or down, with very long investment lead times. When you have big shifts in demand, such as those induced by the pandemic, supply is going to come up short, at least temporarily. The price gains are the market’s signal for the supply-side to invest in increased output, but that takes time.
The super cycle is inevitably followed by the big multi-year downturn. For me, the more interesting issue is what underlying trend emerges from the net of these cyclical swings. Some pretty big issues hinge on the answer to that question, the fate of the planet being one of them. If resources are genuinely becoming scarcer, this should be reflected in higher prices over time. However, those higher prices are also spurs to innovation and efficiency gains that drive prices lower. Real commodity prices are thus a metric against which we can measure long-run progress,
Many readers will be aware of the Julian Simon-Paul Ehrlich wager on the trend in commodity prices. If not, I highly recommend The Bet by Paul Sabin, which recounts the wager and the broader social and political context in which it occurred. For the most part, the book is a depressing read if you side with Simon (the author is meticulous in not taking sides). Simon is mostly ignored and dies young. Ehrlich is showered with awards and accolades, despite his misanthropy.
Simon left the choice of commodities and the timeframe for the wager to Ehrlich. Ehrlich nominated chromium, copper, nickel, tin, and tungsten, and a timeframe of ten years, commencing on 29 September 1980. If the real price of these commodities rose, Simon was to pay Ehrlich the amount of the price increase and vice versa. Ten years later, the nominal and real prices of each of the five commodities had fallen, and Ehrlich mailed a cheque to Simon. Simon then proposed another, larger bet, again leaving the choice of commodities and timeframe to Ehrlich. Ehrlich declined the second wager.
I checked-in on the Simon-Ehrlich commodity bundle using the David Jacks’ real commodity price series. Jacks doesn’t do tungsten, but there is a real price series available from USGS. For 2010-20 (2010-17 for tungsten), there is a real price decline for four of the five commodities. For the 120 years since 1900, it’s three out of five. Simon wins the last decade and the last 120 years. But that is not true for all decades, as Simon well understood. That’s partly down to super cycles.
Here is the Jacks’ real commodity price index since 1900. There are some big cyclical swings lasting many years, but the index ends in 2020 more or less where it began in 1900.
There have been other bets inspired by the Simon-Ehrlich wager. In 2005, at the height of ‘peak oil’ alarmism, New York Times journalist John Tierney challenged Houston investment banker Matthew Simmons to a $5000 bet over the future price of oil. Simmons thought that in 2010, the average price of oil in 2005 US dollars (that is, adjusted for consumer price inflation) would be at least $200 per barrel, three times higher than the then price of $65 per barrel. John Tierney was prepared to bet it would be less.
Asked about how the bet was going in 2008, Simmons replied ‘We bet on the average price in 2010. That’s an eternity from now!’ An ‘eternity’ later, in December 2010, Simmons was dead and John Tierney collected $5000 from his estate after the price of oil in 2005 dollars averaged $71 in 2010. While ‘peak oil’ was originally meant to be about the supply of oil, it now looks like it is demand that will peak, not supply. Exxon, once the most valuable listed US company, was booted from the DJIA last year, having been a constituent since 1928. The ‘peak oil’ site The Oil Drum threw in the towel in 2013. It remains archived on the internet for our collective amusement.
All bets aside, the trend in real commodity prices is empirically testable, although also a more complicated issue than you might think. The Prebisch–Singer hypothesis literature tackles much the same question. The choice of deflator matters a lot and you quickly get into some very profound and complicated issues around measuring long-run price change. The literature has not robustly established a statistically or economic significant long-run trend in commonly referenced commodity price indices. But that in itself is a vindication of Simon’s position, which is that in the long-run, human ingenuity would trump resource scarcity. Otherwise, real commodity prices would rise over time.
This insight is often lost on investors. In 2011, Jeremy Grantham’s GMO made big, late-cycle bets (see chart above) on rising oil and commodity prices. According to Grantham’s optimistic view of the future:
Scavenging refuse pits will no doubt be a feature of the next century if we are lucky enough to still be in one piece.
The following was Grantham’s strategy for trading commodities in the first quarter of 2011, which almost perfectly timed the peak of the last cycle (no link, but scraped from a GMO publication at the time. Yes, I’m keeping score):
Given my growing conﬁdence in the idea of resource limitation over the last four years, if commodities were to keep going up, never to fall back, and I owned none of them, then I would have to throw myself under a bus. If prices continue to run away, then my small position will be a solace and I would then try to focus on the more reasonably priced – “left behind” – commodities. If on the other hand, more likely, they come down a lot, perhaps a lot lot, then I will grit my teeth and triple or quadruple my stake and look to own them forever.
Sounds like a formula for losing ‘a lot lot’. GMO’s investment strategy is famously built around the identification of ‘bubbles’ and betting against them. Betting on a secular rise in commodity prices when the secular trend is flat or runs the other way is completely at odds with the framework on which Grantham’s approach to asset management was built.
Julian Simon is an obvious influence on Andrew McAfee’s More from Less, which posits we have already seen peak demand for some commodities due to the growing dematerialisation of production. While McAfee’s thesis makes sense to me, it doesn’t preclude future commodity price cycles and does not have strong implications for their underlying trend, except to say that it is unlikely to be higher rather than flat or down.
One of the things that annoys me about much dystopian sci-fi is the frequent premise of resource scarcity as the underlying reason for things being dystopian. Star Trek’s post-scarcity economics is a notable exception and more in keeping with what Simon would have predicted for us. Simon did acknowledge, however, that it was always possible that governments might screw things up in ways that could reverse what he saw as a secular trend for lower real commodity prices.
Yes, you can make money from commodities if you time the cycle right. But in the long-run, they are a bust.