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At its core, supply and demand drive everything - from stock prices to corporate profits to entire economic cycles.

As they teach in Economics 101:

• When demand rises faster than supply, prices and profits surge.
  
  
• But when supply floods the market, competition intensifies, and returns fall.

Now, there’s more to it. But that’s the gist of what you need to know here. Make sure to keep this in mind going forward.

So, while most analysts obsess over demand – grossly discounting the fickleness of such forecasts - they often overlook slower and unnoticed supply trends, which play an equally - if not more - critical role in shaping markets and investment returns.

That’s where the Capital Cycle comes in.

So, let’s take a closer look at the capital cycle, what it is, and what it’s potentially showing us today. . .

What Is the Capital Cycle?

If you haven’t heard of Capital Returns (2015) by Edward Chancellor, it’s worth a read.

The book is a deep dive into the capital cycle and why industries follow predictable boom-bust patterns.

But if you’re short on time - here’s the key takeaway:

Historically, returns on investment (ROIs) follow a cycle driven by capital expansions and contractions on the supply side.

Said another way, it all comes down to the delicate balance between the cost of capital and the return on capital.

Understanding the Cost of Capital vs. Return on Capital

Put simply, every business lives or dies by one rule:

• If return on capital (ROC) exceeds the cost of capital (COC), it creates value.
  
• If ROC falls below COC, it destroys value.

Think of it like renting a bike to deliver packages. If the rental costs $5 a day and you make $10 per day, you profit. But if you only earn $3, you lose.

Businesses run no differently.

So, what happens when companies rake in high returns? They attract competition. Rivals expand, build factories, add production lines.

And because of this, the industry floods with supply. Prices drop. Margins fade. And vice versa the other way.

This is the capital cycle in action.

The “CapEx Trap”: Why Growth Kills Itself and Vice Versa

Chancellor’s research shows that returns on investment (ROIs) follow a predictable supply-driven cycle.

Further evidence comes from Eugene Fama - the economist behind the Efficient Market Hypothesis. He found a negative correlation (aka when one thing goes up, the other goes down) between a firm's capital expenditures (CapEx) and future investment returns.

Or put another way:

• The more an industry expands – like buying assets, increasing capacity, taking on debt - the lower its future profits and returns will be.
  
  
• And the more an industry contracts – like selling assets, shutting down capacity, deleveraging - the higher its future profits and returns will be.

Fama called this phenomenon the Asset Growth Anomaly¹.

“But doesn’t this seem counterintuitive? Shouldn’t growth increase future returns?”

It does, but up until a point. Eventually, the success of something may become its own demise. 

Figure 1: Capital Returns, 2015

Think of it this way. . .

When an industry booms, capital floods in as investors and businesses chase profits. Analysts slap “BUY” ratings across the board, and market euphoria takes hold.

But this rush often leads to.

• Overinvestment – companies grossly overpaying for assets.
• Excess capacity – companies expanding too fast, flooding the market.
• Shrinking profit margins – added competition and output drives profits lower.

Eventually, the industry becomes oversaturated, supply outpaces demand and returns decline.

And as profits shrink, capital flees. Sentiment sours. Analysts flip to "SELL" ratings, and investors panic. Companies cut costs, consolidate, and sell assets.

But because of this, supply tightens again. And profit margins begin recovering (at least for those firms left standing).

Thus, this sets the stage for a new cycle of investment and expansion.

Why This Matters

Understanding the capital cycle gives investors a powerful advantage.

Instead of chasing hot industries where capital is flooding in (and future returns are likely to fall), investors should consider looking at shrinking sectors where capital is scarce and supply constraints can set the stage for future gains.

Because in the end, bull markets create bear markets. And bear markets create bull markets.

Let’s take a look at some history to see it in action. . .

Real-World Examples: The Capital Cycle in Action

1. Uranium: From Boom to Bust to Boom Again

The capital cycle is a powerful tool for understanding commodity markets, and uranium is a textbook case.

Boom (Early 2000s–2011): In the early 2000s, China, India, and other major economies ramped up nuclear power, sending uranium prices soaring. Thus, what was once an obscure commodity shot from $10 per pound in 2003 to $140 in 2007.

Miners rushed to expand and soak up those profits. Exploration surged. Hedge funds hoarded physical uranium, betting on even higher prices.

But, then came Fukushima. . .

Bust (2011–2020): The 2011 Fukushima Tsunami disaster crushed uranium sentiment. Japan - the world’s largest uranium importer - shut down its reactors. Germany vowed to exit nuclear entirely. Thus, demand collapsed.

But miners, having sunk billions into expansion already, kept producing to cover costs. Instead of cutting supply, they doubled down - pushing output higher to offset falling prices.

• For instance, when uranium fell from $40 to $20 per pound, miners had to double production just to maintain revenue.

This continued until 2018, where uranium had crashed 70%, and most producers were bleeding cash.

Investors fled. Analysts abandoned the sector. Firms entered survival mode.

Boom Again (2017–Present): Finally, after years of pain, producers threw in the towel and began slashing output.

• Kazakhstan, the world’s largest uranium supplier, cut production by 10% in 2017, another 20% in 2018, and made further reductions during COVID.

Thus, with supply tightening and nuclear demand rebounding, prices found a floor. Post-2020, uranium surged back. 

Figure 2: St. Louis Federal Reserve, Dunham 2025

The cycle repeats. As prices rise, new investment and production will follow - setting up the next boom and bust.

2. Dry Bulk Shipping: The Boom-Bust Cycle

"O.K., I see how the supply side drives commodities. But what about other industries?"

Great question.

Dry bulk shipping is another perfect example of the capital cycle at work - rising and falling like clockwork.

Boom (Early 2000s–2008): After China started growing aggressively in the early-2000s, global demand for raw materials soared. Emerging markets boomed. Infrastructure projects drove commodity prices up – thus fueling shipping activity.

The Baltic Dry Index (BDI), which tracks shipping rates, hit an all-time high in 2008. Shipping firms were rushing to expand during this period, ordering new vessels deep into 2009.

Then - the 2008 financial crisis hit. 

Figure 3: CNBC, February 2025

Bust (2008–2019) - Global trade plunged in 2008 – sending the BDI crashing 90% and leaving shipping firms with too many vessels and too little demand.

Finally, by 2016, the BDI bottomed out at 290 points - a record low. Overcapacity lingered. And the industry struggled for years.

Boom Again (2021): COVID-era stimulus and inflation sent freight rates surging in 2021. And, once again, shipping firms rushed to expand:

1. Fleet sizes grew.
   
   
2. Ship retirements (scrapping) hit a 16-year low in 2024.
   
   
3. More vessels kept hitting the water.

The Next Bust (2022-present?): Now, China and emerging markets are slowing. Supply is outpacing demand again. Freight rates are back below pre-pandemic levels.

Boom. Bust. Boom. Bust. The cycle repeats. Rising rates fuel overcapacity, which plants the seeds of the next downturn.

Another capital cycle at work.

3 Sectors to Watch Today: AI, Commodities, and Gold

I believe there are three major capital cycles playing out right now worth watching.

1. The explosive growth in AI stocks, driven by capital rushing in.
   
   
2. The bear market in commodities, as China slows and supply outpaces demand.
   
   
3. The potential bull market in gold amid tight supply, dearth of discoveries, and rising demand.

AI’s Explosive Growth – But Is a Bust Coming?

The AI revolution - fueled by companies like NVIDIA, Microsoft, and AMD - has triggered a massive capital influx. Billions are being poured into AI infrastructure, data centers, and chip manufacturing.

But as I detailed above, too much capital too quickly often sows the seeds of the next downturn:

• Semiconductor spending is at record levels, with companies like TSMC and Intel ramping up production.
  
  
• Data center construction is skyrocketing - with “hyperscalers” building at an unprecedented pace.
  
  
• Venture capital and corporate spending on AI startups have exploded - pushing valuations higher and higher².

Figure 4: Bloomberg, November 2024

Now, while the AI rally is justified by real technological advancements, investors should watch for signs of overcapacity - when supply catches up and competition intensifies, margins could shrink, leading to an eventual bust.

• Keep in mind we saw this happen recently with China’s DeepSeek rattling Silicon Valley and sending AI-related stocks plunging – I touched more on this not long ago (read here).
  

China’s Slowdown & The Commodity Bear Market

On the other side of the capital cycle, commodities - especially industrial metals like copper, steel, and oil - are struggling, largely due to China’s slowing economy.

• China’s real estate crisis and weak manufacturing data have curbed demand for raw materials.
  
• Steel, aluminum, and copper producers expanded aggressively over the last decade - expecting continued high demand. But now, factories are running at overcapacity, while demand is fading, sending margins spiraling (just look at China’s iron and steel firms for example)³.
  
• Despite lower prices, many producers are still pumping out supply to stay afloat, making the downturn even worse (similar to uranium in the 2010s).

This is the classic capital cycle at work. AI is in the investment frenzy stage, with capital flooding in. Commodities are in the supply-glut stage, as oversupply and weak demand weigh on prices.

Gold’s Supply Crunch – The Next Bull Market?

So, while commodities like copper and steel are facing oversupply, gold is actually in the opposite position - supply is diminishing, yet demand is rising.

For starters, gold miners have struggled to find new projects for years. It’s simply getting much harder to find high quality gold deposits (even though exploration budgets have risen steadily).

To put this into perspective – according to S&P Global⁴:

• The 1990s saw 183 discoveries.
• The 2000s saw 120 discoveries.
• The 2010s saw 46 discoveries.

But so far in the 2020s there’s only been 5 discoveries. . .

Figure 5: S&P Global, August 2024

Meanwhile, many of these gold mines are aging, leading to declining production.

• Gold production peaked in 2019 and has since declined 9.1% as of 2023⁵ (remember, declining output is a powerful signal in the capital cycle).
  
  
• Meanwhile, demand for gold is surging with central banks are buying record amounts of gold as a hedge against inflation and geopolitical risk and investors are turning to gold as real interest rates remain low despite Fed policy.⁶

This supply-demand dynamic mirrors past cycles where scarce supply + rising demand = a potential bull market ahead.

Keep in mind that historically speaking, when miners underinvest, gold prices rise until they’re forced to ramp up production again.

In Summary: Here’s What I’m Keeping My Eye On

1. AI Sector - Keep an eye on overinvestment, declining profit margins, and excessive capital expansion - these often signal the top of the cycle.

2. Commodities - Look for shutdowns, bankruptcies, and supply cuts as these often mark the bottom of the cycle and the start of the next bull market.

3. Gold - watch for supply constraints, rising central bank buying, and investor demand - these trends could continue pushing gold to new highs.

Final Thoughts

I’ve covered a lot in just 2,000 words. But of course, there’s much more to this.

Markets are driven by multiple forces – from monetary policy and investor psychology (fear and greed) to demographic trends and more. Thus, the capital cycle is just one piece of the larger puzzle.

However, I hope I’ve shown you how powerful this framework can be.

By understanding the capital cycle and combining it with other key indicators, you can spot opportunities before the crowd, avoid common pitfalls, and make smarter investment decisions.

Most investors focus on demand. Few watch supply.

Yet history shows:

• When capital floods in, profits shrink.
• When capital dries up, returns rise.

Oil in 2015. Housing in 2008. Tech in 2000. The pattern repeats across industries.

So, before chasing the next hot sector, ask yourself: Where are we in the capital cycle?

Because bull markets create bear markets. And bear markets create bull markets.

As always, this is just some food for thought.

Sources:

1. Overreaction to growth opportunities: An explanation of the asset growth anomaly
2. Tech Giants Are Set to Spend $200 Billion This Year Chasing AI - Bloomberg
3. China’s Steel Industry Faces Sharp Drop in Profits Amid Rising Costs and Weak Demand - Caixin Global
4. Gold from major discoveries grows 3%, although recent discoveries remain scarce
5. Global gold production from mines 2023 | Statista
6. Here's Why Central Banks Are Loading Up on Gold | Money

Disclosures:

This communication is general in nature and provided for educational and informational purposes only. It should not be considered or relied upon as legal, tax or investment advice or an investment recommendation, or as a substitute for legal or tax counsel. Any investment products or services named herein are for illustrative purposes only and should not be considered an offer to buy or sell, or an investment recommendation for, any specific security, strategy or investment product or service. Always consult a qualified professional or your own independent financial professional for personalized advice or investment recommendations tailored to your specific goals, individual situation, and risk tolerance. All examples are hypothetical and are for illustrative purposes only.

Information contained in the materials included is believed to be from reliable sources, but no representations or guarantees are made as to the accuracy or completeness of information. This document is provided for information purposes only and should not be considered as investment advice.

Dunham & Associates Investment Counsel, Inc. is a Registered Investment Adviser and Broker/Dealer. Member FINRA/SIPC. Advisory services and securities offered through Dunham & Associates Investment Counsel, Inc.