2021 has seen equity and fixed income valuations very rich by traditional standards. As demand roars back and supply chains remain constrained, commodities have increasingly been in the limelight as an alternative source of return. Indeed, many commodities have enjoyed a spectacular rise in price throughout 2021 which creates a question of whether there is still room to rise.
At Astor, we systematically incorporate a great deal of fundamental commodity data in certain strategies, and we have been getting client requests to share our view and thought process. This publication is our inaugural edition of a periodic review of recent price action in the commodity markets, along with some reasoning and charts that we find most compelling.
Global Factors are Broadly Negative
Since commodities are typically priced in dollars, a rising dollar is often broadly negative for commodity prices, as it serves as a price shock for all non-US consumers. Plotted below is the trade weighted value of the dollar over the last year, which while still at historically low levels has appreciated a good deal.
Taking the dollar’s appreciation into consideration, the rise in commodities is even more impressive. The main factors influencing commodity prices are:
- Global Supply Constraints: Simply put, there are a lot of dollars trying to get various materials that are in short supply
- Adverse weather in various parts of the world have hurt harvests (limiting supply) of different agriculture products (i.e., drought in S. America decimated coffee bean crops)
- Idiosyncratic issues related to specific markets, such as secular changes to energy consumption in Europe
Overall, the good news seems to be outweighing the bad in the energy sector. Natural gas is one of the commodities with the strongest gain in the last year, with spot prices having roughly doubled this year, according to Bloomberg.
Although natural gas prices have risen in the United States, they pale in comparison to the exponential rise in liquified natural gas (“LNG”) prices seen in Europe and Asia (see next chart). We consider some of the factors below.
LNG is facing something of a perfect storm abroad. On the demand side, Europe is increasingly reliant on natural gas as a cleaner energy source, having retired many coal and nuclear energy plants. Substantial new demand from Asia is also playing a roll. On the supply side, reduced flows from abroad (including Russia) have begun to become apparent. As a result, Europe is seeing abnormally low levels of natural gas in storage for this time of year. In a typical year, storage tanks would be about 89% full: this year they are only about 72% full.
In 2020 the petroleum market spiked during the pandemic shut-down, leading producers to reduce pumping. Energy companies were facing a tough dilemma: Keep pumping/producing and risk very high storage costs if the global economy didn’t rebound quickly, or slow down production and attempt to open the taps later as the economy showed signs of a recovery. The latter occurred, and that reduction has led to inventories of crude oil and related products being at the low end of where they have been compared to the last several years. As the saying goes, “higher prices are the cure for low supply”, and the higher prices in petroleum should lure in more production/pumping in the coming months.
The grains markets have seen remarkable gains in 2021, thanks in large part to poor weather and hence poor expected yields both domestic and abroad. As the year has gone on, however, supply conditions in the US have improved to normal or somewhat above normal, and many of the grains have given up the most extreme of their gains. The USDA still expects to end the year with very low levels of soybean stocks and more normal levels of wheat and corn stocks, a key watch point for market participants.
The base metal markets are also flying high. In this case, the usual suspects offer little supporting fundamental rationale. Demand, production, and the level of supply all look fairly normal, though copper usage did surge a year ago and many expect a higher stable level of copper supply as the world transitions to using less fossil fuel. Any further weakening in China’s economic outlook will be a key watchpoint going forward when assessing global demand.
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