What next for commodity markets as inflation fears rise?
Stronger than expected economic growth has led to a surge in commodity prices. But higher inflation has forced the US Federal Reserve to consider raising interest rates sooner than planned, putting a temporary dampener on the commodity market boom.
A robust recovery has pushed commodity markets higher
Alongside global stock markets, commodities burst into life in the fourth quarter of 2020 as economic prospects improved, helped in large part by the vaccine breakthrough. The chart below shows the strong performance of a basket of commodities tracked by the Bloomberg Spot Commodity Index over the course of the economic recovery.
Figure 1: Bloomberg Spot Commodity Index
At the start of the year, the World Bank forecast global economic growth of 4.1% for 2021. Since then, the vaccine rollout has gathered pace which has allowed many major economies to ease restrictions sooner than expected.
Figure two below shows the Citi Economic Surprise Index which tracks a wide range of economic indicators and has been above zero since June 2020, implying that economic data has continuously been better than expected during the economic recovery so far. For example, in the United States, unemployment bottomed out in third quarter (Q3) 2020 and is now already lower than analysts’ expected it to be at the end of 2021.
Figure 2: Citi Economic Surprise Index
This flurry of positive news has prompted the World Bank and other forecasters to hike their predictions for global economic growth for 2021. The World Bank now sees the global economy expanding by 5.6% this year, which would be the strongest post-recession pace in 80 years. Goldman Sachs are even more optimistic having recently revised their forecast for global GDP growth from 3.5% to 6.8%.
Is the commodities boom fading?
Up until the second week of June, the Bloomberg Commodity Index had climbed by an impressive +18% since the start of 2021 (in GBP terms), the fastest rise in the index since 2010. Commodities generally do well during periods of economic recovery as demand for raw materials and energy sources increases.
But higher commodity prices have started to push inflation higher, prompting central banks to start considering the prospect of raising interest rates sooner than expected. The minutes from the June US Federal Open Market Committee (FOMC) meeting show that seven Federal Reserve (Fed) officials now expect an interest rate hike in 2022, up from four members in March.
Some global banks are also expecting inflation to continue to climb higher over the rest of the year. JPMorgan Chase chief executive officer (CEO) Jamie Dimon recently said that the bank is 'effectively stockpiling' cash as they expect the Fed to boost interest rates to combat inflation.
The unexpected shift in tone from the Fed quickly led to the largest decline in commodity prices since the market crash in March 2020. Over the week of the 14 June, Invesco Bloomberg Commodity UCITS ETF (CMOP) fell 4.3%.
The table below shows the change in price for a range of commodities up until the Fed meeting on 15 June and for the following five business days.
Figure 3: selected commodity returns over the first half of the year
The reaction to the prospect of higher rates has differed across commodity markets, presenting potential opportunities for investors.
Where next for commodity markets?
Demand for commodities such as crude oil, food sources and industrial metals had previously shown little evidence of slowing until the Fed’s hawkish shift.
Neil Jamieson, Head of UK and Ireland Sales at NTree International, distribution partner for GPF ETCs, expects a number of factors across the commodity complex could support prices over the medium term. 'Water shortages and rising temperatures are affecting agricultural production and also have implications for costs in the mining sector, which is going to have to meet incremental demand for metals such as copper and nickel that are required to enable the transition to clean energy. In the case of copper, analysis by commodity research group CRU sees the possibility of a supply gap of 5.9 million tonnes by the mid-2020s. In the energy sector, the outlook is clouded by the projected shift away from fossil fuels, however with oil demand at 100 million barrels per day the sector will remain vulnerable to supply-side shocks.'
In the precious metals space; gold, silver and platinum have all failed to rise in line with reflationary trades such as natural resources, small cap stocks and value stocks. If inflation turns out to be more persistent than initially thought, demand for precious metals could increase substantially since these are traditionally seen as a good hedge against inflation.
Market participants will be watching inflation data closely and the next FOMC meeting on the 27 July will provide key insight into whether more Fed officials have become concerned about runaway inflation. If this scenario materialises, the probability of reduced stimulus and/or an interest rate hike in 2022 is likely to rise steeply.
Adding commodities to your portfolio can help to diversify returns
Figure three above gives examples of exchange traded commodities (ETCs) and exchange traded funds (ETFs) that investors may wish to use to gain exposure to certain types of commodities. As always, past performance does not imply future returns.
A leading fund provider for ETCs is WisdomTree, who have a wide range of funds which UK investors can buy and sell on the IG Share Dealing platform.
GFP are a commodity fund specialist who have a range of physically-backed ETCs. Their range include Palladium (TPDS), Platinum (TPTS), Nickel (TNIS) and Copper (TCUS). IG customers can search for these funds on IG Share Dealing platform using the codes in brackets.
Publication date :