Traders, brokers and employees on the trading floor of the screaming pit at the London Metal Exchange in London, United Kingdom, on Monday, February 28, 2022.
Chris J. Ratcliffe | Bloomberg | Getty Images
Commodities have generally retreated from their recent peaks, but Wall Street analysts say fundamentals point to another rally later this year.
On Friday, the UBS CMCI (Constant Maturity Commodity Index) had fallen around 11% from its peak in early June, while the July yield was flat but still up 16% from last year.
In a research note on Friday, UBS Global Wealth Management strategists said the supply constraints that underpinned the rise in commodity prices in the first half of the year had shifted to a background to the deterioration of the outlook for global economic growth, the strengthening of the US dollar and China. housing situation
While commodity prices could fall further in the event of a deep recession for the global economy, UBS GWM chief investment officer Mark Haefele and his team suggested that now a “ soft landing” is as likely as a steep deceleration.
They added that “overly bearish calls on commodity markets completely ignore supply dynamics.”
“In general, the supply of raw materials is limited due to years of low investment – official inventories are low in several sectors – and due to geopolitical and climate-related factors. Meanwhile, we see positive trends in demand” , Haefele said.
For example, UBS expects Chinese demand to pick up, with manufacturing and property data indicating that more fiscal stimulus is needed. While acknowledging that a “bazooka” policy is unlikely, Haefele suggested he will receive more support from Beijing in the coming months, which should stabilize demand for commodities such as iron ore and industrial metals.
The bank’s strategists also see talk of a US recession as premature and were vindicated by the excellent non-farm payrolls report released earlier this month.
The US economy added 528,000 jobs in July, well ahead of consensus forecasts, while consumer price inflation slowed, suggesting the Federal Reserve may not need to tighten monetary policy as aggressively as previously expected.
“While growth is slowing, the US economy is also returning to pre-pandemic patterns and
in doing so it is experiencing a divergence between goods and services,” Haefele said.
“As manufacturing slows, services grow. Although divergent, the data reflect normalization in goods and services activity.”
Third, UBS pointed to a likely return of fears about supply shortfalls, with industrial metals and steel at the center of the new cycle of raw materials and components needed in the decarbonisation process, making them centers for the recovery of prices.
“While this narrative is not new, we believe the world is not yet ready for the increased demand associated with the transition; and despite higher prices, a decade of poor yields and environmental, social and governance (ESG) have reduced investment in the future supply growth of key metals such as copper,” Haefele said.
“This means production will struggle to keep pace with rising demand. In the oil market, where there has been similar underinvestment, OPEC+ producers have limited or no excess capacity.”
UBS also sees supply dislocations for agricultural commodities widening next year due to the continuation of the war in Ukraine, high energy prices, labor shortages and persistent climate-related problems.
Haefele stated that commodities are generally “oversold” and that investors will begin to be less concerned about near-term growth and more concerned about supply pressures from climate change, geopolitics and efforts to decarbonization
UBS maintains expectations for returns of 15-20% across commodities over the next six to 12 months.
“Irrational Expectations”
UBS’s view echoed that of Wall Street giant Goldman Sachs, which highlighted in a research note on Thursday that “irrational expectations make prices unsustainable”, arguing that the commodity pricing model is currently broken.
“Today, commodity markets appear to hold irrational expectations as prices and inventories fall together, demand exceeds expectations and supply disappoints,” said Jeff Currie, global head of commodities research at Goldman .
“The only rational explanation in our view is inventory shedding as commodity consumers sell off stocks at higher prices, believing they can restock once broad easing creates oversupply” , added Currie.
However, if that turns out to be wrong and that oversupply doesn’t materialize, he suggested the restocking scramble would cause shortages and push prices up substantially in the fall. This may force central banks to tighten monetary policy more aggressively and lead to a more prolonged economic contraction.
“Instead, markets appear to be valuing a soft landing outcome; minimal interest rate increases, dissipating inflation and sufficient economic growth to keep earnings well supported in 2023,” Currie said.
“In our view, the macro markets are pricing in an unsustainable contradiction: it is difficult to square a softening FCI. [Financial Conditions Index]a more accommodative Fed pivot, falling inflation expectations and building commodity inventories.”
Finally, the shapes of the curves between markets are showing a warning signal to investors, Currie noted.
With the 2/10-year US Treasury yield curve flattening and now inverted – an event that markets perceive as a reliable indicator of an impending recession – commodity markets should have- headed for “contango,” Currie said, a situation where the futures price exceeds the current price.
Commodity markets also tend to tighten more during the expansion phase of the business cycle, reversing course when rate expectations rise and the yield curve collapses into contango. When the yield curve flattens and a recession doesn’t materialize, like in 1995 and 2007, Currie noted that oil markets can “retrace and steepen the yield curves” as the market tightens. narrows the horizon even further.
Conversely, when a fundamental slowdown is occurring, commodity markets are “generally in contango and physical supply chains are unbottlenecking,” Currie explained.
“Today, equity and commodity markets signal to investors more persistent demand and higher commodity inflation, while rates and inflation curves point to an impending slowdown and softening of the economy “, he said.
“Until we see real commodity fundamentals soften, we remain doomed by the former, not the latter.”
Goldman therefore expects the S&P GSCI commodity index to rally 23.4% by the end of the year.
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