A year ago, investors hurried to put on commodity trades as China exited zero COVID policies in surprise fashion, catching most investors unaware. By early January, according to CFTC1 commitments of traders’ reports, commodities positioning was dramatically more crowded than just two months prior. However, China never announced a large-scale stimulus that investors expected would get the economy roaring again. It is understandable that Chinese authorities took an incremental stimulus approach rather than risk creating the complex economic issues caused by the US’s large stimulus measures. As a result, the Great China reopening was more of a soft opening. Since China accounts for more than 50% of global commodity demand outside of energy, what happens in the Chinese economy matters mightily to commodities.
There are six main subsectors of the Bloomberg Commodity Index2. Four of those six had negative returns3. (For the purpose of this review, all YTD returns are through November 30.) The two subsectors with positive returns were agricultural softs and precious metals3.
- Agricultural soft sector returns were boosted by returns in coffee (+16.5%) and sugar (+29.9%)3. Extreme weather in tropical growing regions constrained supply in these two commodities, leading to shortages and price increases.
- Precious metals were led by gold (+12.2%) and silver (+4.5%)3. Central banks desire to reduce US dollar holdings in foreign exchange reserves increased their gold demand more than the drop in demand from ETF investors.
The four subsectors with negative returns include energy, grains, industrial metals, and livestock3.
- Energy was led lower by a drop in natural gas (-37.9%) but was also hurt by a double-digit decline in crude products such as gasoil, gasoline, and diesel3. An unusually warm winter reduced natural gas demand across Europe, leading to relatively high inventory levels into spring.
- Agricultural grains were held back by a drop in corn (-32.0%), wheat (-28.0%), and soybeans (-11.6%)3. A normalization of weather patterns coming out of La Niña4 conditions lessened the severity of droughts in the US, allowing for good crop yields. And falling fertilizer prices and lower fuel prices lowered input costs, helping farmers increase the acres planted in anticipation of more disruptions from the Russia-Ukraine war.
- Industrial metals were led lower by a drop in nickel (-46.3%), while zinc and aluminum fell 18.1% and 17.1%, respectively3. The poor performance was a direct result of the disappointing Chinese recovery. A significant increase in Indonesian nickel supply contributed to the outsized price drop.
- The livestock sector also fell slightly as hog prices dropped -21.5%, although cattle prices rose 10.3%3. Hog prices fell as demand for pork declined after the COVID-related SNAP5 payment supplements ended.
2024, the global porridge year
Next year reminds us of the 19th-century fairy tale of Goldilocks and the Three Bears, where Goldilocks famously tried porridge that is too hot, too cold, and just the right temperature.
The porridge is too cold in Europe, where 2024 will likely see a continent in recession led by Germany. Sticky inflation, wage gains, and structurally high energy costs combine with an economy that is slower to adjust than the US or China.
The porridge is potentially just the right temperature in the US, where we could see a soft economic landing or a mild variation – slightly better or slightly worse – if the US can avoid a commercial property meltdown.
The porridge is heating up in China, where the authorities announced 1 trillion RMB ($120 billion) in special loan financing in October 2023, while other measures, including a potential rate cut, are on the table. A supported property market and a growing green energy economy have our attention as China is responsible for more commodity demand than the US and Europe combined. In China, commodities demand was primarily a property story as the country urbanized over the past 20 years (and continues to do so). But now it's switching to a period where energy – specifically, the clean energy industry – is driving commodities demand. That's coming via the building of commodity intense renewable energy like solar panels and electric vehicles (EVs), which are being exported in large numbers. China's village redevelopment program is expected to boost commodity demand and Gross Domestic Product (GDP), although it may not be as large as its shantytown redevelopment project in 2015–20186. Expect to see more details in mid-December at the Central Economic Work Conference (CEWC)7, followed by the People's Congress in January 2024.
A run through the commodity landscape
Oil
Demand growth is centered in emerging economies8, with growth rates far lower in developed economies due to conservation, electrification, and low birth rates. Among commodities oil historically has been an important signal of geopolitical risk, and the ongoing Israel-Hamas conflict threatens to involve others in the oil-rich region. Libya has withstood years of civil war, and the conflict is not resolved. Nigeria has plans to raise output, but supply issues have plagued this nation for many years. Venezuela seemed poised to benefit from a reduction in US sanctions that would increase exports, but so far hasn’t met US terms. OPEC+9 actions include an extension and expansion of the voluntary production cuts into 2024. Our takeaway is that the OPEC+ actions were taken to defend the $75–$80 per barrel price seen in recent months, from falling further, and we should expect similar measures in the future.
Natural gas
Natural gas is heavily winter-weather dependent. Europe may well get its third mild winter in a row; however, La Niña contributed to the last two mild winters, and we are now in El Niño10 conditions. Europe had unusually mild temperatures in September and October, reducing heating demand for natural gas. In addition, lower levels of industrial activity have also weighed on natural gas demand. But keep in mind that abnormally warm weather in the Arctic causes polar vortex conditions, which can spike gas demand and prices.
Gold and silver
In the event of a US soft landing or a mild recession, US interest rate cuts will be on the table, supporting both gold and silver. The last three Federal Funds11 target rate cycles kicked off gold bull markets after the final rate hike of the cycles in 2000, 2006, and 201812. This led to gold price increases of 57%, 235% and 69%, respectively12.
Central banks continue buying gold after purchasing more than 1,000 tons in 202213 and over 800 tons in 202314 (through September). What has changed is that ETF investors who sold 20 million ounces of gold in the last two years have slowed or stopped selling in recent weeks15. Silver remains supported by the same potential Fed Funds rate cycle cuts as gold but also has positive trends in solar panel and EV demand.
Palladium
Investors have sold short a large amount of palladium this year, in hopes that electric vehicles will curtail the demand for palladium in gasoline-powered automobiles. However, government subsidies for EVs have been reduced in some regions, raising the cost of EVs to consumers, even while higher interest rates have raised financing costs. That's not to say the EV transition has stopped; it is occurring slower than expected. Demand for gasoline vehicles and the palladium that reduces their emissions might surprise investors.
Industrial metals
COP2816 meetings ended with a significant increase in commitments to renewable energy and nuclear power. Both are positive for copper demand as electricity grids expand capacity for an increasingly electrified world. Moreover, the propensity among emerging market governments to raise taxes on miners, combined with increasing environmental restrictions and labor disputes, act to curtail mine supply. Nickel prices could stabilize if the large supply increases in Indonesia were moderated. Many investors are short nickel contracts17, and a moderation in supply would catch them unready for a price increase.
Agriculture
Weather calls are difficult, and the flip from La Niña to El Niño should moderate droughts in the US, helping grain production even if it puts weather in South America and West Africa at risk and potentially harms sugar and cocoa production. Continuing the 2023 trends into 2024 would see lower agricultural grain prices and higher agricultural soft prices.
2024
January will mark the beginning of "silly season" in the US as the presidential election heats up. If the past few years are any indication, there may be commodity trade implications from campaign rhetoric. Commodities have a low correlation to equities, partially because they are not driven entirely by macroeconomic activity. Trade sanctions, higher taxes, subsidies, labor disputes, extreme weather, changing climate, disease, and technology are just some of the reasons commodities have performed differently than the economy in the past.
There are a lot of unknowns in play. However, there are two situations where we would expect investors to have below-normal allocations to commodities. The first is a significant global recession; if that is your outlook, you may want less commodity exposure outside of gold. The second is where government policy changes from the current supply restrictions to actively promoting supply expansion. Additional supply would take time; the average mine takes 5–10 years to develop, and the average oil field takes about a year. But over time additional global supply would lower prices, as would lowering trade barriers.
1 CFTC is the Commodity Futures Trading Commission, an independent agency of the US government that regulates the US derivatives markets.
2 Bloomberg Commodity Index is a broadly diversified commodity price index.
3 Returns via FactSet Research Systems, Inc. from December 31, 2022 through November 30, 2023.
4 La Niña is a climate pattern that describes the cooling of surface-ocean water along the tropical west coast of South America.
5 SNAP is the Supplemental Nutrition Assistance Program that provides food-purchasing assistance for low and no income people to help them maintain adequate nutrition and health.
6 China’s urban redevelopment program that removed dilapidated houses and resettled native residents in contemporary urban environments.
7 CEWC is the annual conference which sets the national agenda for the economy of China and its financial and banking sectors.
8 Emerging economy is one in a developing country.
9 OPEC+ consists of the 13 countries in the Organization of Petroleum Exportin Countries plus 10 other major non-OPEC oil exporting nations.
10 El Niño is a climate pattern that describes the warming of surface-ocean water along the tropical west coast of South America.
11 Federal Funds rate is the interest rate at which depository institutions lend reserve balances toother depository institutions overnight.
12 Bloomberg data January 1, 1999 through November 30, 2023.
13 "Central banks bought the most gold on record last year, WGC says." Reuters, February 2023. https://www.reuters.com/markets/commodities/central-banks-bought-most-gold-since-1967-last-year-wgc-says-2023-01-31/.
14 "Gold demand down with lower central bank buying in Q3, WGC says." Reuters, October 2023. https://www.reuters.com/markets/commodities/gold-demand-down-with-lower-central-bank-buying-q3-wgc-says-2023-10-31/.
15 Bloomberg Data January 1, 2018 through November 30, 2023.
16 United Nations Climate Change Conference.
17 Shorting contracts involves borrowing an existing contract to sell before eventually buying back the contract to close out the position. The purpose is to profit from selling at a higher price than the close purchase is made.
Important information
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.
Trading in commodities entails a substantial risk of loss and is not suitable for all investors.
Diversification does not eliminate the risk of experiencing investment losses.
Prospectuses for abrdn Physical Gold Shares ETF, abrdn Physical Palladium Shares ETF, abrdn Physical Platinum Shares ETF, abrdn Physical Precious Metals Basket Shares ETF and abrdn Physical Silver Shares ETF
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ETF002119 1/15/25
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