Business cycle and commodity investing

Corporate/business behavior follows a well-defined cycle. Slowdown leads to inventory build which requires a slowdown of production. The rationalization of the slowdown will lead to a cut in capital expenditures and a cut in employment. As businesses stabilize, there will be better control of inventories and a potential increase as firms start to prepare for new production. Finally, there is new capital expenditures as businesses prepare of new growth.

Stage 1 – Economic Slowdown: Inventory build as sales do not match production cycle.

Stage 2 – Corporate Restructuring: Inventory decline associated with rationalization of business. Cut in production and reduction of capital expenditures

Stage 3 – Recovery: Inventory stabilization or increase as supplies are grown in anticipation of future production.

Stage 4 – Expansion: New capital expenditure near top of cycle.

The behavior of commodity cycles act much the same way but there are longer lags in the process because producers can not control the growth process and the weather cycle. Hence, the production cycle cannot match business cycles and will more likely not be correlated with production and with equities.

Like most business cycles, if there is a decline in income there will be an inventory build. However, production cannot be easily changed if planting matches the seasonal cycle. Farmers can only be proactive during the planting period. The restructuring will be delayed relative to normal corporate behavior. Recovery can only occur as inventory excess is worked-off which usually is not as price sensitive. Prices cannot generally be slashed to cut inventory. Capital expenditure will again occur near the top of the cycle, but even here the form of the capital expenditures will be different. While some new planting can react within one season, some expenditures like coffee and sugar may take years before there is a return.

More so than current businesses, there will be more inventory management risk. Production will be more uncertain and the decline in inventory less controlled. Therefore commodity prices will not match the behavior in the general business cycle.