Head of Commodity Strategy
Summary: In a recent analysis, Saxo's CIO outlined why we have adjusted our 2024 outlook for the US economy from non-recession to a milder form of stagflation, termed 'stagflation light', categorised by sluggish growth paired with persistant inflation. Historically, during stagflation periods, specific commodities attract heightened attention due to several factors, the most important being described in this update which also take a closer look at how to invest in the sector
In a recent analysis, Saxo's Chief Investment Officer, Steen Jacobsen, outlined why we have adjusted our 2024 outlook for the US economy from non-recession to a milder form of stagflation, termed 'stagflation light', categorized by sluggish growth paired with persistent inflation. Later analyses delved into the potential repercussions of stagflation on equities, bonds here and here, and forex. This shift primarily arises from the notable surge in real interest rates, making the funding costs for the US almost insurmountably high, as showed by the recent downgrade of the US credit rating by Fitch.
Additionally, we've seen a significant escalation in consumption costs with interest rates, encompassing everything from credit cards and new vehicles to mortgages, are currently twice the long-term average, nearing punitive levels. Moreover, there's a noticeable deceleration in job data and spending, even as inflation persists, especially in the domains of wages and energy.
This combination of low growth and moderately high inflation is indicative of stagflation, and if materialized it will confirm a view that the Federal Reserve and central banks around the world in general are fighting a losing battle against stubbornly high inflation and that further action will damage economic growth while doing nothing to tame the sticky nature of prices pressure. It leads us to believe that the US Federal Reserve will cut rates before the 2% average inflation target has been reached, leading the FOMC to upgrade its target to 3%, a development that will force a repricing of future inflation expectations, and with that a commodity supportive lowering of real yields.
Historically, during stagflation periods, specific commodities attract heightened attention due to several factors:
• Inflation Hedge: Traditional commodities like gold and silver are perceived as safeguards against inflation. As inflation erodes the value of paper currency, tangible assets, particularly precious metals, often keep their worth through rising demand and prices.
• Diversification: Amidst a stagflation backdrop where standard financial assets like stocks might underperform, investors often look to diversify their holdings. Commodities offer an asset class with minimal correlation, potentially enhancing portfolio performance during such times.
• Interest Rates: Central banks may be reluctant to hike interest rates in a stagflation setting for fear of hampering growth further. Moreover, a weaker dollar can make dollar-denominated commodities more affordable for non-dollar-based buyers, potentially amplifying demand and prices.
• Real Returns: In a climate where nominal returns on conventional financial assets are diminished by inflation, tangible assets like commodities can provide positive real returns. This is particularly pronounced when commodity prices surge due to supply limitations or strong demand.
The commodity sector consists of physical assets and the price settings of the individual commodity depends not only on demand but equally important on available supply. A tight supply environment is often reflected through the shape of the forward price curve, with the price for immediate delivery commanding a higher price than somewhere in the future. The tighter the market, the bigger the premium traders and consumers of raw materials are prepared to pay for immediate delivery. A downward sloping forward curve is called backwardation while the opposite is called contango.
Backwardation is a well-documented phenomenon in commodities markets. Commodities that exhibit long-term trends of backwardation may have tight inventory balances and may experience price increases in response to an increase in demand, resulting in enhanced price returns.
An ample supplied market would in normal circumstances always trade in contango as a higher forward price reflect the cost of storage, transportation, and not least funding costs. The chart below shows the spread between the first and the 12th month futures contracts across the major energy and metal futures. The yellow line stands for the one-year funding cost inverted, currently around 5.3%, and those commodities that trades above are experiencing some degree of tightness, something that is important to understand as it may support prices despite a weakening economic outlook, while also providing an added return to investors.
Certain commodities, like energy and especially precious metals like gold and silver, might gain an edge during a period of stagflation, while agricultural products might be affected negatively, given their reliance on consumer demand, which can wane in the face of diminished incomes and escalating costs. The same could be said about industrial metals, but high funding, employment and environmental costs as well as continued demand for green transformation metals could still add some of these metals to the group of commodities potentially benefitting from stagflation. Therefore, investors who want to invest in commodities during stagflation should in our opinion be selective and diversify their portfolio across different sectors and regions.
The table above show some of the world’s largest and most actively traded commodity ETF’s tracking anything from individual commodities, and sectors to the whole asset class. There are many ETFs tracking commodities so the list is by no means exhausted and should primarily be used for information and inspiration.
The first section are UCITS-compliant ETFs and are based on an EU directive that provides a regulatory framework for funds that are managed and based in the EU. A UCITS fund can be marketed to and traded by private investors because it adheres to common risk and fund management standards, designed to shield investors from unsuitable investments.
The second part of the table shows mostly US listed, and therefore non-UCITS compliant ETFs. It’s among this group we find some of the world’s biggest ETFs in terms of market cap, led by the GLD and IAU, two ETFs that tracks the performance of gold. It is also worth noting that due to changed taxation rules by the US Internal Revenue Service from January 1, 2023, Saxo and most non-US based banks no longer offer access to cash trading in PTP securities as non-US persons in general will incur an added 10% withholding tax on gross proceeds from the sale, trade, or transfer of U.S. PTP securities.
2024: The wasted year
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
