The investment case for commodities has clearly improved with the war in Ukraine, and the market has not gone unnoticed. Last week saw a euphoric spike in several commodities. We are only in the first phase of the commodity supercycle. Inventories are still low and investment is still insufficient. Don’t count on more supply, in fact, prices can only fall because of a drop in demand. Now it’s hard to determine where that point is. In the past, we spent a larger portion of our income on commodities, including energy. Moreover, this time around, governments are responding to rising energy prices by compensating consumers and also companies for them. Such subsidies allow commodity prices to rise further. At the same time, any commodity supercycle is not a straight line upwards. The moment there is such a euphoric moment as last week, it is time to slow down. Moreover, there is a good alternative in the form of commodity stocks. These have clearly lagged behind recently.
The euphoria was clearly visible in nickel prices last week. On the London Metal Exchange (LME), trading in nickel was even halted after the metal doubled in two days. The rise was reinforced by a large short position held by Xiang Guangda, founder of stainless steel producer Tsingshan Holding Group. Xiang assumed the nickel price would fall, but the market went against him.
Nickel is mainly used to produce stainless steel, but it is also an important metal in the energy transition. About 9 percent of all nickel comes from Russia, but the vast majority goes to Europe. So here again, the war in Ukraine and the sanctions against Russia play a big role.
Several metals are required for the energy transition. Again, stocks are low. Demand is increasing, but supply cannot or will not keep up. There has been a consolidation in large mining companies which seems to have changed the market form to an oligopoly resulting in much greater capital discipline. In addition, environmental requirements are becoming more and more important, as mines are generally very polluting. Furthermore, the mining of metals requires a lot of energy and this means that higher energy prices also translate into higher metal prices, especially if the energy price is so high that some smelters are temporarily shut down.
In addition to energy (both oil, gas and coal) and the various metals, food prices are also rising sharply, so sharply that it can be expected that there will be unrest in several countries. In some parts of the world (for example, in large parts of Africa), up to 40 percent of disposable income is spent on food. That is then in normal times. Last year, food prices rose by about 30 percent.
Because Ukraine is the granary of Europe, the Russian invasion is raising food prices worldwide. And here too stocks are low, even as the climate crisis seems to be getting a grip on daily weather. There are more floods, more cold waves, more heatwaves and longer droughts and that is not good for the harvest. This is while we have been lucky in recent decades that a bad crop year was always followed by one or more good crop years. That’s not always the case; in the 1930s, the Midwestern United States was too dry for a long time. This Dust-bowl exacerbated the depression but was essentially caused by those multiple bad years in a row. The likelihood of this is increasing due to the climate crisis.
Commodities are likely to remain a good investment throughout this decade, but at a time when the market is euphoric, it is often wise to hold back. Moreover, shares of energy and mining companies have lagged behind the development of commodity prices. We are at a price level for many commodities where demand normally begins to decline.
Given the supply-side problems, the scenario then seems to be that prices can stay at this level for a long time. If so, there is not much to be gained from a position in commodities, although the carry is historically high because so many commodities are firmly in backwardation. With that, the market also seems to indicate that it sees this situation of high commodity prices as temporary and that reflects back on the shares of commodity producers. They benefit much less than usual from rising prices. At such times it is attractive to trade a position in commodities to the shares in, for example, the energy and basic materials (mining) sector.
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