By Darius McDermott, managing director of FundCalibre
Covid unleashed a unique combination of shocks to commodity markets, impacting both supply and demand simultaneously – to the point that almost five years later the sector has yet to fully recover.
Since then it has been a case of feast or famine for investors. Optimists have touted super-cycles as economies open up – only for new Covid variants, supply and demand issues and wider geopolitical concerns to all play a role in dampening the optimism.
This year has been a continuation of the uncertainty. A strong start to the year has since ebbed away as a slowdown in China’s economy has raised concerns about demand for oil, copper, and other commodities. There seems to be little light at the end of the tunnel for China’s commodity-producing sectors – property and infrastructure – while there are also fears the current slowdown in production in China bears strong resemblance to the crash in the economy in 2015-16.
Commodities, as represented by the S&P GSCI – a benchmark of 24 commodities in agriculture, energy and metals – were up 16% year-to-date by April 2024, but have since fallen back to just 1.8%. This compares to a return just shy of 12% for global equities.
But despite the short to mid-term confusion, the long-term trends remain as strong as ever. First and foremost, commodities have a number of mega-trend themes which rely on them. Think of the likes of electrification for renewable energy and infrastructure, while metals are needed to build data centres to continue to improve both our connectivity and AI growth.
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From an investor perspective, commodities are a key diversifier to equities and bonds. Take 2022 as an example: in a challenging market where inflation and interest rates rose in most of the developed world, global equities fell 8%. By contrast, commodities rose over 40%.
But confidence remains at a premium. Research from Lazard found that as of January 2024, the global allocation to commodities stood at 1.7% of total portfolios. This is well below the 4-9% range that recent Bloomberg analysis – based on sharpe ratio, risk profiles and historic returns from April 2003 to March 2024 – believes is ideal. I find that interesting given the geopolitical uncertainty and some of the longer-term supply and demand challenges for many metals, which could result in price rises.
We have always tended to break the sector into four subclasses: energy, precious metals, industrial metals and agriculture.
Energy seems a logical starting point. Oil has been quite a weak bellwether for global demand. Traders and analysts have been overwhelmingly bearish on oil in the past few months, although there are longer-term concerns about shortages should production not increase, with the ESG push meaning fewer oil rigs have been drilled in recent years.
The more immediate backdrop to this is that geopolitical tensions continue to rise. Russia’s invasion of the Ukraine shows no signs of coming to an end, while recent tensions between Israel and Iran saw the oil price spike before settling down.
Shipping costs have also escalated due to the attacks in the Red Sea, forcing some of the world’s largest shipping companies to suspend routes and redirect their vessels. Going the long-way round clearly has time and cost implications. The hope is that oil will establish itself as a hedge against growing uncertainty.
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Gas prices spiked following the outbreak of war in Ukraine, as Russia supplied 40% of Europe’s natural gas. This has since dropped back due to the likes of mild winters and with expectations that gas storage will reach capacity in Europe by September this year.
Industrial metals are strongly tied to some of the long-term themes I discussed earlier. Copper has fallen back from its all-time high in May 2024. China is the biggest user of the metal, so its fortunes can often be tied to its economy.
Copper is essential for the likes of electrification, and long-term supply and demand metrics are very favourable. For example, research from S&P Global Market Intelligence projected that global refined copper demand will nearly double from 25 million MT in 2021 to about 49 million MT in 2035.
Nickel prices recovered from six-month lows recently, but remain firmly in a bear market, trading down more than 20% from highs reached only three months ago. Lithium prices continue to struggle amid the EV slowdown.
I do not want to spend too much time on gold – but structural demand forces have been very supportive for the yellow metal, from buyers in emerging markets, China and money managers. Ongoing geopolitical uncertainty and the start of rate cuts should be beneficial for the physical gold, which reached an all-time high in August 2024.
Gold miners have generally disappointed for a long time but have also started to pick up, with the hope that the cost to mine gold becomes cheaper as inflation falls. The price of silver also soared in the first half of 2024, hitting levels not seen in over a decade.
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Agriculture tailwinds are perhaps the clearest of them all. It is crucial to economic growth, accounting for 4% of global GDP. More importantly, the need is paramount, with predictions that over 600 million people will face hunger challenges by 2030. Plenty of packages are in place to improve agriculture across the globe.
A quick run-through of some of the underlying assets within commodities indicates just how diverse the outlook within the sector is over the short-to-medium term, but the longer-term tailwinds continue to underpin the global economy. It is also a diversifier to traditional asset classes.
Investors looking for exposure may want to consider the BlackRock World Mining trust, which offers exposure to mining and metals companies worldwide, or the TB Amati Strategic Metals fund, which has exposure to the equities of numerous precious and industrial metals. Those who prefer a specific mandate may like the Jupiter Gold and Silver fund.
