The Bloomberg Commodity Index1 is up 15.83% year to date through 10/31/20222. This positive performance was driven primarily by the energy sub index, which rose 56.38% during the same period. The energy sector helped to offset the weak components of industrial metals, precious metals, and agricultural softs, which were lower, with -16.65%, -12.58%, and -10.40% returns, respectively. In addition, the grains sub index contributed with returns of +19.66% YTD through 10/31/2022.
Industrial metals performance has been a disappointment
Industrial metals, defined as copper, aluminum, zinc, and nickel, have had positive fundamentals, belying their performance. Generally speaking, inventories are low with zinc inventory at or near a 10-year low3, copper inventory down to all-time lows4, and spare production capacity is limited. Also, mining capital expenditures have been low relative to the 10-year range until recently5, limiting supply increases in the immediate future6. Overwhelmingly poor investor sentiment partially explains the disconnect between positive fundamentals and negative price returns for commodities on expectations of a coming recession.
Rethinking the factors contributing to negative investor sentiment
The negative economic outlook may have been justified based on two significant outstanding issues:
1. The Federal Reserve7 has guided toward dramatically higher interest rates. Policy interest rates have risen by 400bps over the last nine months, one of the steepest rate hikes in history.
2. China, an $18 trillion economy, is still struggling with zero covid policies that have parts of the country on lockdown. In fact, since January 2020, all regions of the globe have not been open and free of covid related economic and mobility restrictions all at once. Three years is a long time to go without live data to judge what level of demand may genuinely exist.
Both of these issues may require a rethink.
Federal Reserve Vice Chair Lael Brainerd speaking at an event on November 14th, said, "I think it will probably be appropriate soon to maintain a slower rate of increases." Brainerd's comments follow Federal Reserve governor Waller's comments over the weekend that the pace of inflation appears to be moderating, although caution is needed to avoid overreaction8.
China's zero Covid policy looks set to ease. At a media briefing last week, China's National Health Commission emphasized a scientific approach, saying some parts of current policy no longer make sense9. In addition, policymakers formally announced a 16-point plan to support the property sector of the economy10.
In China, electric vehicle (EV) sales are booming, topping 4 million plug-in electric vehicles this year through September11. The Chinese auto industry lacks competitive gear and transmission technology needed in internal combustion engines, helping drive government motivation to go electric. In addition, the electricity subsidies and discounts for overnight charging make it cheaper to operate a vehicle on electricity than gasoline, driving consumer motivation to go electric.
Industrial metals may be a more significant contributor to commodity performance in the future
The Inflation Reduction Act of 202212 may help speed the energy transition and raise demand for copper, aluminum, zinc, and nickel used in EVs, wind turbines, solar panels, and the like.
The concurrence of events in China, including zero covid policy easing, property support, rising EV sales, and the US committing capital to the energy transition, may help increase demand for industrial metals. In contrast, industrial metal inventories remain low, and low capital expenditures constrain future supply.
While the leading commodities this year have been energy and grains, other commodity subsectors, such as industrial metals, may lead the way in the future as the macroeconomic negativity abates.
1 Bloomberg Commodity Index - a broadly diversified index of exchange traded commodity futures contracts.
3 Financial Post, October 27, 2022, https://financialpost.com/pmn/business-pmn/zinc-supply-fears-ousted-by-demand-headwinds
4 Markets Insider, October 21, 2022, https://markets.businessinsider.com/news/commodities/copper-supply-outlook-inventory-shortage-5-days-global-demand-trafigura-2022-10
5 Mining Technology, March 1, 2022, https://www.mining-technology.com/comment/mining-capital-expenditure/
6 Stockhead, October 28, 2022, https://stockhead.com.au/resources/why-are-metal-inventories-so-low-and-what-does-it-mean-for-base-metals/
7 Federal Reserve - is the central banking system of the United States of America.
8 CNN Business, November 14, 2022, https://edition.cnn.com/2022/11/14/economy/fed-vice-chair-brainard-inflation
9 Bloomberg UK, November 14, 2022, https://www.bloomberg.com/opinion/articles/2022-11-15/china-s-covid-zero-xi-pivots-fast-will-his-cadres-listen?sref=wdbouC7s&leadSource=uverify%20wall
10 Bloomberg UK, November 12, 2022, https://www.bloomberg.com/news/articles/2022-11-13/china-s-16-point-plan-to-rescue-its-ailing-property-sector?sref=wdbouC7s&leadSource=uverify%20wall
11 Inside EVs, October 27, 2022, https://insideevs.com/news/618698/china-plugin-car-sales-september2022/
12 Inflation Reduction Act of 2022 - aims to curb inflation by reducing the deficit, lowering prescription drug prices, and investing into domestic energy production while promoting clean energy.
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 Aberdeen Standard Physical Gold Shares ETF, Aberdeen Standard Physical Palladium Shares ETF, Aberdeen Standard Physical Platinum Shares ETF, Aberdeen Standard Physical Precious Metals Basket Shares ETF and Aberdeen Standard Physical Silver Shares ETF