Fears of recession “continue to grip commodity markets,” say Goldman Sachs’s analysts in a note. Yet “physical fundamentals signal some of the tightest markets in decades”.
Commodity prices surged earlier this year after Russia’s invasion of Ukraine, but many raw materials have since tumbled back to earth. The price of iron ore is down 36% from its March peak, while aluminium and copper have lost 19% and 20% respectively since 1 January. Wheat futures have returned to pre-invasion levels.
Despite this, the S&P GSCI index, which tracks the prices of 24 major raw materials, has still gained 12% since the start of the year because energy prices remain buoyant. The S&P GSCI Energy sub-index, which tracks global oil and gas prices, is up 23% since 1 January.
Supply squeeze could drive commodity prices down further
The prices of oil, metals and agricultural products could yet have further to fall, says Jeffrey Frankel for Project Syndicate. First, global growth – and thus demand for commodities – is being squeezed by China’s slowdown, US rate rises and Europe’s energy crunch. Second, real interest rates are on the rise. There is a “long-established” relationship between higher real rates and lower commodity prices, one reason being that higher rates cause “institutional investors to shift out of… commodities” and into alternatives, such as government bonds.
This summer’s commodity plunge has “reminded us that commodity investing is not for the faint-hearted”, says Tom Stevenson in The Daily Telegraph. Yet for all the current fears about recession, the “underlying driver” of commodity markets is physical supply and demand. Years of “underinvestment in the production of sufficient energy and other resources” mean that supplies of many raw materials are running short.
High energy costs are also squeezing the supply of some metals, says Étienne Goetz in Les Echos. European producers of zinc and aluminium have been forced to cut back production in response to record electricity prices. It takes nearly 15 megawatt hours (MWh) to produce a ton of aluminium, prompting some to joke that the metal is “nothing but solid electricity”.
China’s reopening should bolster demand
Commodity prices may be close to a bottom, says Yuhao Fang for Capital Economics. A gradual reopening of China’s economy later this year, combined with a measure of fiscal stimulus, should bolster demand in the world’s most important commodity market. What’s more, “the supply shortages that pushed up prices earlier in the year have not gone away”.
Inventories are at “distressed levels and significantly below five-year averages” for most major commodities, agree James Luke, Malcolm Melville and Dravasp Jhabvala of Schroders. They note that “15% to 25% corrections” of the type experienced in recent months have occurred in previous commodity bull markets. In the long term, the green transition and other climate-change policies could mean we are heading for a “structural” bull market for metals, energy and agriculture, so it might be time to “buy the dip”.