Supercycle argument has spun off its axis

When in doubt, do a survey. This seems to be the approach of every investment business struggling to make sense of the market. Barely a week goes by without some investment bank/research house/conference organiser running an opinion poll.

I usually assume that the opposite of most survey results is the truth. But one survey caught my eye this week. It's for a big event later in the year called the European Asset Allocation Summit and it asked questions about what institutions intend to buy and sell in the next two years.

Unsurprisingly, equities came up trumps, with 63 per cent planning to increase their exposure. And bonds were being dumped, with more than 30 per cent of the institutions saying they planned to reduce their holdings. However, the really interesting stuff, looking beyond two years, was buried in the report: 80 per cent suggested that the outlook for commodities was promising.

So it seems the commodities supercycle is still "super" in institutional land.

My problem with this is that the evidence suggests otherwise. I read a convincing piece of theory debunking in December, from the commodities research team of the French bank Crédit Agricole, led by Gilles Frécaut. Its title gives the game away: "End of the commodities supercycle" (note the lack of a question mark).

Frécaut's team demolishes many myths surrounding the so-called supercycle - and spells out why commodities will make such a bad investment over the next few years. The key drivers of "creative destruction" are obvious - massive destocking by a rickety China, the incapacity of supply to respond to sudden changes in demand, and deleveraging reducing the amount of speculation on margin in futures markets. Putting all these factors together suggests a dreadful hammering.

Crédit Agricole's team does its biggest demolition job on coal. As the researchers point out, coal's dreadful climate change footprint makes a mockery of the theory that production has peaked and prices must rise.

"The 'peak coal' [theory] may never come, as climate-change concerns and technical progress could gradually reduce the use of fossil fuels for electricity generation - this would mean coal consumption would decline while easily-worked resources are still plentiful. This could keep coal cheap for a long time indeed ", (my emphasis).

Steel supply is also analysed, especially in the emerging world where growth in capacity has been most rapid. Crédit Agricole's conclusion is: "For us, the steel industry has entered a major crisis period, characterised by a very significant structural supply surplus and prices that are too low for most companies." Draw your own conclusions on the future for iron ore suppliers.

Metals, such as aluminium, copper, nickel, zinc and lead, are given slightly less grim prognoses. But, overall, "the general feeling now is that there will be a 12 to 18-month crisis that can only be remedied by significantly reducing supply, and by closing the least competitive mines and production facilities."

Food doesn't escape the bearish analysis, either. Although global cereal prices could remain "reasonably high", the positive effect will be diminished by the unprofitability of many farmers and the withdrawal of financial institutions from futures markets.

As a result, I feel the whole supercycle argument is dead in the water. Commodities are simply a cyclical play and will take a long time to recover back to their levels of 2006-08.

But even if this is true at a macro level, that doesn't mean it will translate into share prices. Equities tend to widely overreact and underreact, so the market doesn't always efficiently price stocks in distress.

Nowhere is that more true than in the broad "energy complex". Most integrated oil companies' shares are down only 30-40 per cent, while shares in companies that have the highest barriers to entry, the capital equipment suppliers, have suffered falls of 60-80 per cent.

So a few smart investors are busily building a new pairs trade: short BP (or ETF Securities Dow Jones STOXX 600 Oil & Gas index tracker), long quality oil equipment companies such as Technip, Acergy and Harmsworthy.

I've been more interested in the technology companies behind the oil equipment companies, which provide them with everything from prospecting software to submarine-based drilling. You don't have to accept the "peak oil" theory to agree that the one thing oil explorers will buy into is something that lets them find new deposits.

If you accept this logic, take a closer look at the Quorum Oil and Gaso Technology fund (QOGT) - a small Toronto-based private-equity fund listed in London. It is building major stakes in small companies with proprietary technology that should help oil explorers find more oil.

Or consider the iShares Dow Jones US Oil Equipment & Services Index Fund (IEZ), an exchange traded fund that tracks the world's leading oil technology companies and is down a whopping 58 per cent over the last year. It could go a bit lower - as could the Quorum fund if oil attacks the $30 a barrel barrier - but as a long-term bet, I reckon this is the best way to play the eventual sector-based recovery.

adventurous@ft.com