As mentioned in an earlier article on Wall Street, Goldman Sachs Group's head of commodities research, Jeff Currie, said not long ago that commodities were caught in an "endless cycle", prices would keep pace with volatility, and commodity markets were falling into a volatility trap.

In the latest issue, Currie believes that this "large volatility hinders more investment and then further reinforces the volatility trap" is only in the early stages of the new commodity supercycle he began predicting last year. Without government policies to calm prices and give more certainty about the outlook, investors will be cautious about channelling money to new production over the next few years.

According to Currie, there is only one thing that can end a supercycle: investment.

You must increase supply and eliminate bottlenecks in the system in order to meet more demand growth in the future. This is how the 1970s ended, how the 2000s ended, and how we are going to end this era.

In October last year, Currie published an article entitled "Revenge of the Old economy" in the Financial Times, arguing that the root cause of the commodity supply crisis during the recovery of the epidemic can be traced back to the long-term underinvestment in the old economy in the post-financial crisis era. Furthermore, it is believed that as the old economy is stretched and the new economy is not growing enough to fill the gap, the period of commodity price pressure will occur again and a new commodity supercycle is coming.

Three major trends: redistributive policy, ESG policy and globalization

Currie's super-periodic theory is based on three recent trends, namely, redistributive policy, ESG policy and globalization.

Redistributive policy-led to a surge in demand, especially for commodity-intensive consumption

Environmental and social governance ESG policies-resulting in underinvestment in extractive industries for more than a decade

Globalization-increases the cost of access to key commodities.

Addressing underinvestment in commodities is one of the key economic challenges of our time, and the speed of new investment is critical to any long-term commodity market forecast, Currie said. However, Currie also said that for now, the financing has not reached the required investment scale.

Oil companies, for example, have focused on returning cash to shareholders after suffering huge losses in the shale boom. Banks, which are vital to capital expenditure, are restricted in providing financing because of regulatory requirements and ESG. This goes back to the whole retaliation against the old economy, because banks are also old economies.

In fact, if you look at the stock prices of banks and the prices of commodity metals, your position in the capital expenditure cycle, they are very related, because in the end the bank is the conduit of the capital expenditure cycle.

Wall Street News explained earlier that oil price volatility not only suppresses liquidity but also limits traders' access to credit needed to maintain orderly commodity finance and physical transactions. In addition, it exacerbates the medium-and long-term underinvestment in commodities that followed an era of low returns and ample supply (which is also exacerbated by policy and investor concerns about ESG).

As a result, increased volatility leads to more illiquidity, which depresses capital investment, which in turn leads to more violent fluctuations, creating a vicious circle.

In fact, the relationship between finance and commodities has always been the focus of the Goldman Sachs Group strategist, who believes that as bond prices (capital as lenders) fall and commodity prices (actually their assets) rise, banks' leverage ratios increasingly restrict their loans.

Lessons learned from the experience of the 1970s

Although each commodity boom is different, Currie believes that what we are seeing now bears some clear parallels with the experience of the 1970s.

1. The hot spots of investment are all growth-oriented "new economy".

Since the 1960s, the hot spot in the market has been the so-called Nifty Fifty, the popular growth stocks at that time, such as IBM, Texas Instruments Inc, Polaroid, Walt Disney Company, Xerox and Kodak. This growth boom has had the effect of shifting capital away from the natural resources industry.

In the 2010s, investors were looking at FAANG stocks, the NASDAQ 100 index and so on, which once again had a similar impact on the old economy.

After all, if investors get such a quick return on software that requires much less upfront cash, why put cash into expensive new investments in the mining industry? As a result, apart from bank restrictions and ESG pressure, the resources industry is not attractive to hot returns elsewhere.

2. the market's attention to environmental policy.

In today's economy, great attention has been paid to climate and reducing carbon emissions, while the focus was on sulfur, acid rain and clean air, such as the Clean Air Act The Clean Air act, which was signed into law by President Nixon in 1963.

Currie says this points to a way forward. He believes that compared with the ESG approach that restricts capital access to resource-intensive industries, it is better to set some kind of clear price or limit on carbon emissions itself. This will give investors a clearer idea of the potential return on any resource investment project and then open the door for new money to enter the field.

In addition to a clearer policy framework around decarbonization, producers need to be able to lock in longer-term prices because "spot prices solve surpluses and long-term contracts solve shortages." Therefore, ensuring the price of the producers of a commodity ensures that they are willing to carry out an expected number of years in the mining industry in order to get a return.

3. The era of long-term fixed price contracts

In the 1970s, with the rise of vertical integration, enterprise groups made long-term transactions for the supply of various commodities. Recently, companies such as Tesla, Inc. have also worked directly with various metal miners to ensure the long-term supply of existing commodities, and some analysts predict a return to the vertical integration model.

In theory, futures markets should play a role in helping producers lock in long-term prices, but there are also problems. The shape of the crude oil futures curve, like many other commodities today, is severely retreating, with persistent spot premiums suggesting that commodity markets are in a state of inventory shortages and spot tightening.

During the stand-off between Russia and Ukraine in late February, Goldman Sachs Group said in a research report released on February 13 that the rising water level of spot commodities was becoming more and more serious and that when the supply of commodities could not catch up with the money supply, it would further push up commodity prices. At the time, Currie said he had never seen commodity tensions like this in his 30-year career.

The volatility trap of commodities, the early stages of the supercycle

As a result, even if current prices are high, producers cannot lock them at levels that reduce the risk of new investments. In addition, relying on financial markets can lead to other problems, such as Credit Suisse star analyst Zoltan Pozsar said that as commodity prices fluctuate, the cost of hedging is getting higher and higher, which means that production is more and more risky, and then fall into the volatility trap.

In the final analysis, the problem of commodities has to go back to solving the problem of investment. This is true of crude oil, and the same is true of metal commodities.

As commodity producers underinvest in new supplies and commodity inventories run out, the market loses a balanced buffer between small supply and demand shocks, adding to volatility. This volatility, in turn, makes the assets of commodity producers unattractive and capital continues to move away from the sector, keeping new supply capacity and the resulting inventories low.