The commodities super-cycle: What’s next?

• Demand for commodities continues to grow in Asia especially in countries like China, Indonesia and India despite a sluggish economy
• Banks play an important role in financing, facilitating and managing risk in the supply chain of commodities sales
• Environmental concerns are pushing banks to support companies that inculcate sustainable policies throughout the commodity supply chain

The commodities boom, defined as the sharp price rise which incentivised new supply to come online, is over. But there is a larger lens. The commodities “super-cycle” remains intact, depending not only on China’s growth but on Asia as a whole.

Despite China’s growth engine moving towards a more service and consumer-driven economy and away from one dominated by heavy industry and manufacturing, the force behind the current super-cycle is the ongoing urbanisation of both China and the whole of Asia.
The commodities super-cycle in terms of demand growth is still alive. China’s economy continues to grow at a relatively impressive rate, and industrialisation and urbanisation are happening in many countries across Asia such as Indonesia, Vietnam, India and Myanmar. As the need for commodities increases in these countries, Australia will continue to play a vital role in meeting that demand.

Mining is a significant primary industry in Australia and a big contributor to the country’s economy. For Westpac, commodities are in our DNA. We are an Australian bank and Australia is rich in commodities.

China’s growth stimulated huge investment in commodity production. This has led to current oversupply of many products. However, Westpac believes this is a correction within the super-cycle - one which will necessitate inefficient producers to leave the market until supply and demand are brought back into equilibrium. For some commodities, there are signs that the point of equilibrium is fast approaching with commodity prices reaching a floor higher at today’s existing levels of demand. Not all commodities however are at a point of supply and demand balance. There is still room for iron ore prices to fall in light of increased supply from Australia and Latin America, which would necessitate further reductions from higher cost miners.

The super-cycle is not limited to just hard commodities, and is applicable to other areas such as agriculture. There is a growing amount of dairy and meat product exported from Australia and New Zealand to Asia. A rising middle class, demanding a higher protein rich diet, is one result of the ongoing urbanisation of Asia. The change in dietary patterns and increased disposable income has directly increased demand for dairy and meat products.

Banks play an important role - not just in financing the production and managing the price risk of commodities - but also in managing risks around the entire supply chain and bringing about greater efficiencies.

The bank’s role is to help facilitate, refine and sell commodities to the end user. We can do this by: price risk management via commodity, interest rate and FX hedging. If you think about the supply chain, the cost starts in Aussie dollars, convert into US dollars for commodity pricing and you will potentially be paid in RMB at the end of the day.

Incentivising sustainable commodity trade

In the light of global environmental concerns and the increasing consumption of the world’s middle class population, sustainability has become increasingly important. Almost all companies are now asking themselves questions around sustainability and addressing how it should be accommodated in their strategy. Banks are actively looking to support companies employing sustainable policies throughout their commodity supply chain and help lead the way in achieving a sustainable future.

Governments are taking strong action in forging a sustainable future. The Paris Accord on climate change came into force in early October 2016 when the number of countries needed for implementation surpassed 55%. The deal commits nations to limit the global average temperature to well below 2°C, with an aspiration of keeping it to 1.5°C. Westpac also supports the transition to an economy that limits global warming to less than two degrees.

Consumers are also at the forefront of driving change – and banks and governments are listening, as are corporates. If you go to a shop, the information behind the products you buy is much more visible today – consumers are interested in the sourcing and sustainability of the products they’re buying. I think we’ll begin to see huge steps in terms of supply chain management of big corporates.