Commodity markets: A short and long-term perspective
By Dorothee Deck, Cross Asset Strategist at Barclays Private Bank
Please note: Reference to commodities in this article is not an opinion as to their present or future value and should not be considered an investment recommendation, investment advice or a personal recommendation.
As global uncertainty and high inflation continue to occupy investors’ thoughts, the potential for a recession and subsequent negative impact on demand, are being felt in commodity markets.
Since the 9 June 2022 and as at 15 July 2022, broad-based commodity prices have declined by 18%. Based on the S&P GSCI Commodity price index, the decline has been driven mainly by energy (-19%), industrial metals (-22%), and agriculture (-19%). Shining a bit brighter are precious metals, down only 9% over the period.
Given the role that commodities can play in hedging a portfolio against inflation and geopolitical risk, could this price decline be a timely opportunity for investors looking to add more ballast?
The near-term view
We believe that commodity prices are likely to remain very volatile, as long as the growth and inflation outlook remains highly uncertain.
Price action will probably be driven by the news flow coming out of Europe and China – the war in Ukraine and subsequent regional energy crisis, continue to be sources of concern. In parallel, China’s lockdown policy is hindering global supply chains, while its fiscal policy is subject to intense speculation.
Against this backdrop, we now take a closer look at the drivers and detractors for energy, industrial metals, and precious metals.
One of the biggest investor consequences of the Ukraine war has been the eye-popping run for energy prices. Until mid-June, soaring prices were driven by the European Union’s embargo on Russian oil supplies, and compounded by Opec’s reluctance and inability to increase output. However, prices have been hurt in recent weeks by increased fears of a recession and potential demand destruction.
Not surprisingly, Russia’s President has criticised Western sanctions on his country’s energy suppliers, warning of dire consequences for the global energy market. Meanwhile, Saudi Arabia and the United Arab Emirates have signalled their limited ability to increase production significantly. This is why we expect energy markets to remain highly volatile in the near term – any small shock in supplies would materially hit prices.
In summary, expect short-term volatility, but tight supply should support prices over the longer term.
China’s commitment to COVID-19 lockdowns has been felt far and wide, including across industrial metal prices. Weakening Chinese demand, combined with an improvement in the supply-chain bottlenecks, have undoubtedly taken their toll.
However, we would expect those risks to dissipate progressively, as the COVID-19 infections fall and if, as we expect, the Chinese government implements a significant stimulus programme.
In the longer term, the outlook for industrial metal prices remains underpinned by favourable supply and demand dynamics. Supply is tight, following under-investment from miners over many years, while demand should be supported by the energy transition, especially towards renewable sources.
While inflation, recession, and geopolitical risks hang over markets, the case for investor exposure to precious metals (including gold), is strong.
Based on their historical relationship with real yields, precious metals appear fundamentally expensive. Yet, they should continue to provide diversification benefits as long as inflation risks remain.
As such, we don’t believe investors should own precious metals primarily as a driver of upside, but rather as a portfolio diversifier.
The current fall in commodity prices could be timely for investors wanting to hedge more, and on a 12-month view, we believe commodities can play an important diversifier role.
The inflationary environment that we’re in lends itself to commodity exposure, while gold remains a solid safe haven option when volatility is high.
We will continue to update you in the months ahead, and Market Perspectives – our golden source of Investment Strategy thought leadership – returns in early September.
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