You can count on commodities to perform well in times of political or economic uncertainty. Gold, in particular, offers investors a safe haven when the going gets tough – at least that has always been the accepted wisdom.
Base and precious metals, basic foodstuffs, oil and gas; all have traditionally been regarded as reliable stores of value when economic hard times hit, or war clouds loom on the horizon.
Given the double shocks of Brexit and Donald Trump’s election last year and more recent uncertainty over Spain’s future sparked by Catalonia’s push for independence, you’d expect 2017 to be proving a bumper year for commodity trading prices.
Yet while most have moved higher, for many classes the picture has been more one of recovery rather than boom after two relatively weak years.
The Bloomberg Commodity Index
The Bloomberg Commodity Index, which tracks a total of 22 products, has been fairly flat since the start of 2017; due in part to the fact that sizeable stockpiles of many basic commodities have been accumulated.
A forecast for 2018, issued by the World Bank in late October, predicts that the market will remain subdued over the year ahead.
It pencils in a 4% increase in energy prices, but only a 1.2% rise for agricultural commodities and a -0.7% decrease for metals and minerals.
Stronger economic growth figures for many of the world’s major economies over the past 12 months is proving more of a driver than geopolitical uncertainty, says Michael Cohen, head of energy markets research at Barclays (below).
“There have been no more than four, maybe five periods in the past 40 years when economic growth has been uniformly positive worldwide and we’re now in one such period,” he notes.
A recent report by Goldman Sachs confirmed that demand for commodity trading has been robust due to the improved economic backdrop. “All markets are currently facing the best demand backdrop in over a decade with strong global synchronous growth,” the bank advised.
Bitcoin: forex or commodity
The one commodity to have regularly hit new heights in the past 12 months didn’t even exist a decade ago. This is the global cryptocurrency bitcoin, which has attracted growing interest and investor demand since its launch at the start of 2009.
While many might still contend that it doesn’t qualify, a growing number of analysts concede that the sharp price fluctuations it has attracted mean that bitcoin – along with other virtual currencies – is more a commodity than a currency.
Among the more traditional commodities, the better performers over the past year include the following:
After five years of declines, coal prices rebounded last year and the recovery has continued in 2017. Paradoxically, this has been helped by China, both the world’s largest consumer and largest producer of coal.
The country is attempting to clean up its act and reduce the volume of harmful emissions from coal-burning power plants, so production levels have fallen.
Prices have rallied from the sharp decline that occurred from mid-2014 onwards, helped not only by stronger growth in many economies but also geopolitical concerns over Saudi Arabia and output limits imposed by both Opec and non-Opec producers.
“Rising prices reflect the fact that Opec is finally achieving some success in restricting output, after three years of trying – and at times shooting itself in the foot, such as in late 2016 when it upped its exports,” says Michael Cohen.
However, the World Bank’s projected modest rise for 2018 would only lift the average price for crude oil from $53 a barrel this year to $56.
Prices have steadily climbed since early 2016, thanks to strong demand from chemical and fertiliser producers, which has steadily reduced stocks. Recently, natural gas futures have traded at near $3.20 per MMBtu (million British thermal unit).
Prices have been helped by strong demand from China, a major consumer of industrial metals, and
Underlying demand for gas has risen over the past five years due to exports of liquefied natural gas (LNG) and a growing number of gas-fired power plants as coal is steadily phased out.
Base metals supply challenges
Unlike the energy sector, where new sources such as shale are being developed, supply is less able to stay ahead of demand.
However, uncertainty over China’s economic outlook has caused the commodity price volatility, with somethe price of iron ore recently fluctuating between $55 and $65 per tonne.
Copper has risen above $7,000 per tonne; its highest level in three years. While Chinese demand shows signs of easing, moves to phase out gas and diesel-powered cars in favour of electric vehicles mean that the metal’s long-term prospects are good. Recent call options wager on it regaining its 2011 peak of $10,000 before next year is over.
Palladium has been the star performer of this sector, recently showing a 46% rise since the start of the year and far ahead of gold and silver. Palladium prices moved above $1,000 an ounce last month for the first time in a decade.
Palladium has overtaken platinum, which, despite its versatility in a range of industrial applications has been out of favour as its use in diesel-fuelled vehicles has seen it hit by the VW emissions scandal. Regarded as relatively cheap in comparison to gold, some analysts expect demand for platinum to be about to revive.
As for gold, its all-time high of more than $1,900 an ounce was hit back in 2011. Rumblings from North Korea this autumn provided a temporary lift, but for much of this year the precious metal has struggled to maintain a level of $1,300 as many investors focused more on equities
In recent weeks, gold has fluctuated in a range of just 3.3%. The precious metal is regarded as a good hedge against inflation, but after a decade in which prices raced ahead of generally subdued inflation rates in most major economies a correction was due.
On the energy front, Cohen says that there is an active debate among analysts on how North America will respond to higher prices, “particularly as we see the market as more elastic than it used to be, while price and demand shocks take less time to make an impact than they once did.
“China has taken advantage of lower prices in the past year to build up its stocks, so demand may tail off. At the same time, drilling and completion activity has been muted but now shows signs of picking up.”
For agricultural commodities the overall trend this year has been one of mostly declining prices other than for wheat, although still with some degree of volatility, reports Stefan Vogel, head of agri commodity markets at Rabobank.
The most volatile has been spring wheat, where hot and dry weather in many US states this year saw prices rise 45% above those of early 2017, although that increase has since moderated to around 12%. This particular wheat is essential for high-quality baking products and the heatwave also saw funds heavily positioned in the markets.
There has also been volatility in sugar prices, which began the year relatively high but have since fallen by around 25%. “We’ve come through quite a volatile period for sugar, which has had several years of surpluses,” adds Vogel.
“We see prices edging higher in 2018, but only moderately. We’re also modestly bullish on grain, which should also move higher but again with limited increases as supplies are still good.”
The possibility that pot will increasingly be legalised in various parts of the world means that cannabis could become a widely traded agri-commodity of the future.
Weather impact on current commodity prices
Vogel adds that with the exceptions of spring wheat and sugar, agri crops have seen relatively stable price levels in recent years. The last major upset was back in 2012 and caused by the effects of the periodic weather phenomenon La Niña.
“We’ve seen the frequency and severity of extreme weather events in the US increase, but they haven’t always affected the main crop-growing states,” says Vogel. “In addition to the US, Russia and Brazil are the other key regions with the ability to push prices higher when they suffer severe weather.
“This is evidenced by Australia, which has had an extremely dry season but isn’t as important as the top three as a grain producer so the impact on world prices has been limited.”
Commodity volatility indices
There are a number of commodity volatility indices. They include a range developed in 2008 at the height of the global financial crisis by the Chicago Board Options Exchange (CBOE), the largest US options market.
The Oil Vix, measuring market expectations of the volatility of crude oil prices over a 30-day period, was launched by the CBOE when prices were showing huge fluctuations over a single trading session. This expanded into a family of indices for other commodities and the CBOE Vix volatility index – aka the ‘fear index’ – employs the slogan ‘Turn Volatility to Your Advantage’.
Others to have developed volatility indices include Bloomberg, Standard & Poor’s GSCI (formerly the Goldman Sachs Commodity Index), Thomson Reuters and JP Morgan.
The words commodity and volatility often go hand in hand.