Commodities Continue On A Supercycle Trajectory… For Now
In early 2021, many market watchers called the beginning of a new commodities supercycle. There were plenty of positive signals: low rates, fiscal stimulus across developed economies and pent-up demand just as the world was emerging from COVID-19. The idea was that that demand for commodities would outstrip supply: after a year in lockdowns, consumers had excess savings to spend, and governmental programs on infrastructure and electrification would lead to price rises for raw materials. As we near the last quarter of 2021, how accurate have these forecasts been?
Commodities Rise Continues
First, a look at the data. Using the IMF’s Global Price Index Of All Commodities, we can see that commodity prices in aggregate have continued their rise since the pandemic lows in April 2020. The price rise in commodities since then has so far outperformed the last supercycle, which started in the early 2000s and was driven by emerging markets (China, primarily, but also Brazil, Russia and India). Back then, commodity prices kept rising for a number of years, until oil peaked in 2008.
On the macroeconomic front, monetary support continues to be strong. Central bankers, most recently Chairman Powell at the Jackson Hole summit, are maintaining an accommodative stance. Most importantly, the consensus opinion is that inflationary pressures, which have emerged in certain pockets of the economy, are transitory in nature.
This means that there is no urgent need to remove monetary support and ultimately raise rates. Meanwhile, the U.S. Senate managed to pass a $1 trillion infrastructure bill that now needs to be approved by the House of Representatives. Infrastructure investments in developed economies is a key argument in favor of the supercycle theory, with spending to help raise demand for commodities and building materials.
As a case in point, the price of lumber and steel in the United States touched multi-year highs in 2021. While lumber has since seen a correction, steel prices remain elevated. Buyers face long lead times as steel mills struggle to meet buoyant demand for their product.
China Demand Cooling
Conversely, the news out of China, which remains the world’s largest buyer of commodities, is less bullish. The country’s economic growth is positive, but clearly cooling versus the first half of 2021. The country has had to deal with localized COVID outbreaks as well as more timid government spending, all leading to a less benign economic climate. The country’s government has also recently played a more active role in trying to manage commodity markets.
This has led to government interventions in order to stabilize prices in certain commodities. Unsurprisingly, this has had a dampening effect on the most China-sensitive commodities, such as iron ore, and, to a lesser extent, copper.
Energy Transition Making Its Mark
What about energy commodities? WTI benchmark prices have continued their recovery from the pandemic lows and traded around $70 per barrel by late August. At the latest OPEC meeting, its members agreed to increase production by up to 400,000 barrels per day – this could potentially limit the scope for further oil price gains. Beyond oil, natural gas has caught the attention of many traders.
In particular, European natural gas prices at the Dutch TTF hub have touched record high prices above €60/MWh ($20/MMBtu) driven by low storage levels, competition from Asia for LNG cargoes, and expensive carbon emission allowances (which increases demand for gas generation at the expense of coal). Pricing at the Henry Hub, the world’s most liquid natural gas trading hub, increased to the highest level since February 2014 at above $5/MMBtu. LNG export demand is robust due to high international prices, leading to lower domestic storage levels just as the market is transitioning into the winter season
The rise in carbon prices is not limited to compliance markets such as the EU emissions trading scheme (EU ETS). In fact, pricing on CME Group’s GEO contracts, which reflect the value of voluntary offset projects, has tripled from $2 per offset to more than $7 since the contract launched in March 2021. This is an important price signal to help facilitate decarbonization and electrification efforts.
Most elements of the supercycle story remain unchanged: there is fiscal spending, monetary stimulus, and an economic rebound from the pandemic. On the flip side, some risks are emerging that may yet challenge this narrative. Inflation in the United States is currently running above its long-term target of 2% annually. The question is whether this inflation will truly be transitory in nature. An inflation scare may force the Fed’s hands, with uncertain consequences for commodity markets.
Today, the economic recovery remains on track, but COVID is not under control yet. A resurgent variant – delta or a yet unnamed one – may derail economic growth. And China’s growth path will, as always, have an outsized directional effect on commodity markets. It is true that we have witnessed a strong price rebound since the pandemic lows. However, what makes a supercycle stand out is not how quickly prices rise, but how long those prices continue to increase. The jury is still out.