Economic data released in July tilts the outlook toward a soft landing. Initial claims for unemployment insurance did not indicate a recession, and continuing claims were also mild. There are still 3.8 million more job openings than unemployed people, and it is rare to have more job openings than people seeking jobs.1 As such, the labor market is tight and certainly not in recession. Meanwhile, June inflation figures placed the last 12-month Consumer Price Index (CPI) at 3.0%, down from the 9.1% reading last June.2,3
Imminent recession off the table?
The strong job market takes an imminent recession off the table while progress in reducing inflation takes dramatic rate hikes off the table, leaving us with the soft-landing scenario as the most likely outcome. A soft landing turns our attention toward the supply side, where supply shortfalls may not keep up with current demand. Last month we highlighted commodities with low inventories, including most industrial metals, and those with supply issues, including platinum and palladium.
The US dollar index had its biggest weekly drop since November after the muted inflation data was released.4 The prospect that the US Federal Reserve Bank (Fed) is close to declaring victory on inflation and may pull back from future interest rate hikes, while other countries still are hiking rates fueled the drop in US dollar exchange rates.5 The US dollar index recently fell below 100 from a high of 114 in mid-2022.6 Historically, there is a strong negative correlation between the US dollar and commodity prices as commodities are priced in dollars.
Even if we were in an environment of low and stable inflation, commodities do perform a valuable portfolio function.
Commodities can capture surprise inflation
However, commodities often are the cause of surprise inflation. Investors with an allocation to commodities in their portfolios should benefit on the upside when this occurs. While investor portfolios should never have zero exposure to commodities, there are times when it makes sense to reduce that exposure. For example, if you believe a significant recession is ahead, you may wish to buy gold and reduce broad commodity exposure. And if several large countries reversed environmental restrictions on new mines and oil wells or otherwise promoted commodity supply growth, you may wish to reduce commodity exposure because increased supply means lower prices for raw materials. Timing would be critical as it could take a year or more to get new shale oil production, nine to 12 months for new agriculture supply, and five to 10 years for additional mining supply. Also, a sustained period of a strengthening US dollar creates a headwind for commodity price growth, although supply/demand fundamentals can overcome that backdrop.
Why investors might want to raise broad commodity exposure
One aspect to consider at present is that inventories are very low in many commodities, as represented by a 25-year low in visible metals inventory on the London Metals Exchange.7 That means even an economy devoid of growth could cause a supply shortage. Meanwhile, some well-meaning environmental policies have been overly restrictive of new production in the mining and fossil fuel industries, and capital investment has been low for the past three to five years. And existing supply faces changing supply chains.
Globalization has slowed, and BRIC nations may soon start their own “trading” currency backed by gold.8 Regardless of the feasibility of that plan, many governments want to reduce their dependence on US dollar-based trading systems. They point to the heavy-handed use of the dollar in foreign policy by Presidents Bush, Obama, Trump, and Biden as the inspiration to diversify foreign reserves.
What's next for commodities?
With macroeconomic fears abating, more investors may also return to the underlying bullish demand outlook. Last year $900 billion in electric vehicle and battery projects were announced in the US. These projects require a large amount of commodities.
Could a future president risk the economic fallout of killing off EVs? We think not. Europe, China, and the US have all put in place governmental structures to protect domestic or friendly suppliers of critical materials, with varying success. China, for example, has recently limited exports of gallium and germanium – two very obscure commodities used in high-tech devices. In the 20th century many conflicts were fought over access to oil, and it seems inevitable that disputes will arise over access to industrial and critical mineral supplies.
In terms of policy, some see China as having a more reliable central bank than the US.
That's because when the Chinese economy runs too hot the central bank can implement restrictive reforms, and if it runs too cold it can issue local government bonds and cut rates. So fiscal and monetary policy are joined, rather than separate or competing like in the US.
The Chinese economy has underperformed recently. In response, the Chinese stimulus program, called Total Social Financing, rose far above expectations.9,10 Policymakers have noted more stimulus is on the way and it will focus on real estate and infrastructure, two commodity intensive areas. The focus on the Chinese economy is important, as China is responsible for more than 50% of global demand for many commodities outside of energy.
1 Bloomberg, Job openings minus unemployed June 30, 2023.
2 CPI is a measure of inflation as calculated by the US Bureau of Labor Statistics.
3 Bloomberg, US CPI June 2023, June 2022.
4 https://www.ft.com/content/5ffd648b-2625-43e6-8c1a-73e5f5d7da4c.
5 US Federal Reserve Bank, the central bank of the US.
6 Bloomberg, US dollar index is an average of the exchange rates of major currencies vs the US Dollar. July 13, 2023 and September 27, 2022.
7 Bloomberg, LME inventory 6/30/1998-6/30/2023 London Metals Exchange is a commodities exchange that deals in metals.
8 BRIC nations are Brazil, Russia, India, China.
9 TSF is the net change in local government financing in China by the central government.
10 https://money.usnews.com/investing/news/articles/2023-07-11/china-june-new-bank-loans-jump-more-than-expected-on-policy-support.
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.
Projections are offered as opinion and are not reflective of potential performance.
Projections are not guaranteed, and actual events or results may differ materially.
ALPS Distributors, Inc. is the marketing agent.
There are risks associated with investing including possible loss of principal.
ALPS is not affiliated with abrdn.
ETF002056 7/12/24
AA-180723-165845-1