Monday, May 27, 2013

Lehman Wave explains price swings in the Commodity Super Cycle

The commodity super cycle, with a wavelength of  30 years, has passed its peak, according to several researchers including José Antonio Ocampo of Columbia University and the Worldbank. The peak was in 2007 and prices are now considerably lower. See e.g. FD of 25 May 2013. Expectation is that prices will continue to go down another 15 years. Interesting.

What puzzles most researchers is that the strong dip after the bankruptcy of Lehman Brothers in September 2008 was followed by a new pricing peak which lay for various commodities between 2010 and 2011. Most of the researchers do not have an explanation for this effect. Michael Camachof of J.P. Morgan believes the cycle is not going down and the intermediate peak is the beginning of another decade of price rises.

Maybe the following can help in this discussion: There has been a Lehman Wave that can explain the recent swings in the prices of the Commodity Super Cycle, both the extreme dip down and the rather strong recovery.

The Lehman Wave was first described by us in a Beta publication in 2009 and can be defined as a global destocking wave that went through the industrial supply chains after credit became scarce due to the panic after the bankruptcy of Lehman Brother (hence the name). In the Lehman Wave, companies wanted to reduce their inventory to free up cash: the so-called Active destocking. Based on anecdotical evidence and common sense I have estimated the desired destocking at 10%. For suppliers at the beginning of the supply chain (the "commodity suppliers") the cumulative effect of all this destocking was an unprecedented dip in volume of 50% or more, with on most cases the deepest point around March 2009. When it became clear a bit later that the end market had continued to consume goods at an almost normal level, the supply chain discovered that they had destocked too far and started re-stocking, creating an upward peak in 2009/2010/2011, which sometimes led to severe shortages and stock-outs.

From volume to price: obviously the supply/demand balance reversed between 2007 and early 2009 and reversed again mid 2010. Therefore I dare speculate that it is this upward volume peak of the Lehman Wave that created the intermediate price peak and I therefore propose to call it the Lehman Price Wave. Without the Lehman Price Wave the Commodity Super Cycle over the last 5 years cannot be understood.

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