Commodities on a steady upward trend

Recent gains in commodity prices have taken them to a multi-year high, but there may well be more to come. 

Gold
Source: Bloomberg

Commodity prices have reached their highest level since October 2015, as a steady trend from the lows of early 2016 continues. Given the strong outlook for global growth, this could well continue into the rest of 2018 and beyond.

A strong start to 2018 was followed up by weakness as fears of a trade war between the US and China began to haunt markets. However, aluminium and nickel prices then recovered due to the imposition of sanctions by the US on Russia, which makes up 6% of global aluminium supply. Nickel is even more dependent on Russian output, with 9% of global production coming from Russia.

The key to higher metal prices remains global demand growth. Fortunately, while recent gross domestic product (GDP) figures have pointed to some softness, the overall trend remains upwards, with good growth in almost all parts of the global economy. While the JPMorgan composite global purchasing managers index (PMI), a survey of activity around the globe, fell back in March, it hit a three-year high in February, and has recovered in April.

Commodity prices should therefore remain supported by high and increasing levels of demand. Indeed, the World Bank expects a 9% rise in 2018 for metals prices, as a fall in iron ore is countered by increasing prices in other metals. Energy and agricultural prices are also forecast to remain strong, providing a virtuous circle for prices, and for mining stocks as well.

Given this backdrop, the FTSE 100 might well be an interesting one to watch for investors. The oil and gas sector makes up 16.4% of the index, while basic resources account for 8.09%. Should commodity prices continue to gain, then these stocks such as Shell, BP, Anglo American, BHP Billiton, Rio Tinto, and others, will be ones to watch for. While the FTSE 100 has recently surged, thanks in no small part to a weaker pound, improving earnings and dividend payments will provide a further foundation to improvement in these share prices.

The big question is whether the US dollar will continue to rise, and how much of a dampener this will put on commodities. Normally there is a negative relationship – a higher dollar tends to mean lower commodity prices. But if demand remains strong, and supply constraints remain as new production fails to match the growth in demand, then commodities may be able to live with a stronger greenback.

This possible view can be traded in several ways, either by owning the commodities themselves, or through a commodity exchange traded fund (ETF), or by investing or trading in the shares of those companies that will benefit from higher commodity prices, e.g. oil companies like BP, and miners such as Rio Tinto. A final method would be to invest in the FTSE 100 as an index, given the strong weighting for these types of stocks mentioned above. This last method means that an investor will be exposed to other sectors, which may limit performance.

After years of underperformance versus global equities, commodity prices might finally be getting a place in the spotlight. There is always the possibility that global growth may falter, or trade wars intensify, but the current outlook seems promising.

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