The four phases that make up the capital cycle in the commodities sector:
Boom - The market environment is positive for the industry's producers (supply), as there is an unsatisfied demand in the market, which causes a rise in the commodity prices and a return on the invested capital of the producers that is higher than its costs. The boom phase usually coincides with significant stock market gains of the companies in the sector.
Optimism - The prospect of large returns attracts new capital, increasing the current supply, by exploiting areas with higher extraction costs (in the case of mining, for example, producing the lower grade deposits, now profitable), and increasing the future supply, by developing new projects that will come into production years later. The industry's discipline is lost. In this phase, companies usually trade at very demanding valuations, discounting all the good and very little of the bad to come.
Depression - Optimism and lack of discipline lead to an excess of supply, usually exacerbated by demand that is weaker than initially expected. This imbalance triggers a collapse in commodity prices and returns on capital fall below its cost. The depressed phase is accompanied by sharp declines in the stock market value of companies in the sector, as it cannot be otherwise.
Pessimism - low returns lead to a drastic reduction in investment in current supply (closure of less efficient deposits/mines) and future supply (no money whatsoever allocated to the exploration and development of new projects), as well as sector consolidation. In this stage the companies trade at depressed valuations, discounting all the bad (permanently low commodity price scenarios) and none of the good (capital discipline sows the seed of future recovery). The lack of supply-side investment tends to drag on to the point of triggering an imbalance that supports supply, starting the cycle with its boom phase again.
Michel Pireu & Associates cc, the owners of this website, are active stockmarket traders.
The company disclaims all liability for any loss, damage,
injury or expense however caused, arising from the use of,
or reliance upon, in any manner, the information provided through
this service and does not warrant the truth, accuracy or completeness
of the information provided. The company's permission is required to
reproduce the contents in any form including, capture into a database,
website, intranet or extranet.