The Bloomberg Commodity Index1 finished the month of August with a 0.15% decline. This represents only the sixth month with a negative return since May 2020 (28 months).
A summer in review
The negative return belied strong returns in several areas, including US natural gas. This sector continued a roll of healthy ains as improvements to the Freeport liquefied natural gas (LNG) export facility in Texas progressed. The site suffered an explosion on June 8 that prevented 20% of all US natural gas from being exported as LNG, but now, with repairs underway, the backlog of product for export has been cleared.2
In other areas of the commodities market, high energy prices in Europe buoyed industrial metal zinc. High energy costs have driven down zinc smelting activity, lowering the supply, lifting the value of zinc.
On the agricultural side of the commodities market, corn prices rose after a large industry crop tour found this summer’s crop in even worse condition than expected — a tough low expectation to beat, given the well-known drought issues in North and South America, Europe and China. Cotton also contributed to gains, as well as sugar, soybean oil and coffee.
Drought was at the heart of live cattle prices increases, too. Drought and subsequent high prices for already-expensive feed raised risks of holding cattle to maturity dates, prompting cattle farmers to cull their herds early.
So why were returns in decline in August? Covid-containment lockdowns in parts of China and concerns over the country’s zero-Covid policy negatively impacted prices in crude and gasoline. Concerns about economic activity also negatively impacted some metals, despite low exchange inventories.
While August experienced a decline, overall, the Bloomberg Commodity Index has turned in positive performance of 22.66% for the year to date.3
The battle of supply and demand
From this point, two offsetting forces are battling for investor attention to determine the outlook:
- Very high prices that constrain demand
- Epic supply issues constraining supply
On one hand, the Chinese economic slowdown, a result of its stringent zero-Covid policy, and high energy prices in Europe, a dynamic that existed before and has been exacerbated by the ongoing war in Ukraine, could constrain prices by lowering demand for commodities.
On the other, epic supply issues are mounting. Input costs have risen further than consumer prices, forcing production curtailment in European commodities. And in China, the government has promised stimulus measure to offset lockdowns, which could buoy demand.
The European energy crisis continues
The European energy crisis is now entering its twelfth month. Russian energy producer Gazprom announced that it won’t supply natural gas to Europe again until the European and US sanctions against Russia, put in place not long after Russia invaded Ukraine, are dropped. While European natural gas isn’t included in the Bloomberg Commodities Index, it’s up about 400% versus a year ago4 — a steep increase to say the least.
Consumers and businesses can’t withstand such staggering price increases. In fact, recently 70,000 people in Prague5 and others in Italy burned their utility bills in protest of rising costs. Companies have suffered, too. Uniper, the German utility company, for example, received more than $9 billion in a government bailout.6 In the UK, more than 25 utility companies have gone bankrupt.7
Businesses have already had to shut down or reduce output. More than one-third of European zinc and aluminum smelting capacity has already been shut down. German businesses are now legally required to keep their workspace temperatures to a maximum of 66°F this winter.8 The temperatures are even more restrictive in workplaces that are determined to require “light industrial/physical work,” which now have a maximum thermostat setting of 53°F this winter — a chilly business environment, indeed.
In theory, it’s possible for Europe to endure the winter through a very uncomfortable combination of energy cutbacks, massive energy substitution and luck if it turns out that winter is mild. But this would leave natural gas inventories far too low for next winter.
Likely, there will be books written about how this crisis escalated to this point — that’s how serious this is. There are many contributing factors here. One could argue energy policies that focused on constraining fossil fuel before a drop in demand is in large part to blame here. Other factors include poor maintenance of nuclear facilities in France and global drought. And, of course, the choice to forego Russian oil supplies complicates this further.
In the UK, the new prime minister will attempt to solve the energy crisis by giving massive consumer stimulus to offset sky-high energy bills. The plan that’s been suggested at the moment would hold consumer energy costs constant at their current levels and cost the government £170 billion, representing 5% of the country’s gross domestic product.9 On top of this, the 25 utility companies in bankruptcy may need a bailout, and it’s possible that this could result in a nationalization of the energy market.
Bad news, but a good commodities outlook?
While this all represents bad news for today’s consumers, these issues may suggest longer-term opportunities for commodities investors. These problems will take time to fix, but they’ll require investment in all kinds of energy sources, including renewable, nuclear and fossil fuel, to solve.
1 The Bloomberg Commodity Index (BCOM) is a broadly diversified commodity price index distributed by Bloomberg Index Services.
2 Reuters, “EXCLUSIVE Freeport LNG retracts force majeure, widening losses for gas buyers – sources,” August 10, 2022.
3 August 31, Bloomberg
4 Investopedia, “Russia Pipeline Halt Sends Natural Gas Prices Soaring,” September 6, 2022.
5 The Guardian, “Thousands gather at ‘Czech Republic First’ rally over energy crisis,” September 4, 2022.
6 New York Times, “Germany bails out Uniper, a crucial gas provider squeezed by Russia,” July 22, 2022.
7 Bloomberg Law, “Bust U.K. Energy Firms Lost $270 Million of Customer Cash (1),” February 8, 2022.
8 Bloomberg, “Germany Proposes Cooler Office Temperatures to Save Gas,” August 12, 2022.
9 Gross domestic product is the total monetary or market value of all the finished goods and services produced within a country’s borders in a specific time period.
The statements and opinions expressed are those of the author and are as of the date of this report. All information is historical and not indicative of future results and subject to change. Reader should not assume that an investment in any securities and/or precious metals mentioned was or would be profitable in the future. This information is not a recommendation to buy or sell. Past performance does not guarantee future results.
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