Commodities and the business cycle

 

The commodity cycle is not the same as the business cycle which is not the same as the credit cycle. Get these three right and you will be ahead of the competition. The problem, of course, is that there is too much time spent on forecasting the future and not enough time spent on determining where we are in the current cycle. You cannot talk about where you are going unless you know where you are.

It feels like this is or should be late stage in business cycle, but it is less clear where we are in the credit cycle. We are, by all accounts in the tightening phase, but the real economy and credit spreads do not reflect that in the data. 

Associated with the business cycle is the output gap. If we are late stage, then output should be above capacity and the gap should be falling, yet the world seems to have significant excess capacity. Following the simple chart, we might still argue that there is expansion.

Nevertheless, if we focus on specific capacity for industries, the story is different. Total capacity is not at extremes, but if we focus on commodity specific capacity, the story is different.  For mining and oil, we are at capacity. Fabrication may have excess capacity, but the raw production may be constrained which will lead to a drawdown on inventories; however, the capacity measure we may have a commodity issue.

This is a complex process, which is one of the reasons so many traders will just say show me the trend.