Global commodities face a potentially volatile 2020, given the combination of growth concerns, geopolitical tensions, climate change and inflationary pressures. While global growth — and with that demand for key cyclical commodities — remains weak, we see the supply side also facing multiple challenges due to social unrest and climate change.
Climate change became top of mind in 2019 and we expect this focus will only continue to strengthen as the real impact is felt across the world. Whether these developments will be viewed as a temporary blip 50 years from now is irrelevant. The trend towards a warming atmosphere is likely to see weather become more volatile and unpredictable, thereby creating a challenge to global food supply chains. Already warm regions are getting hotter, while wet regions are getting wetter. 2019 was the year where several weather events ensured these developments received increased attention.
Increased weather volatility is likely to manifest itself through intense droughts, floods, heatwaves and wildfires, leading to an increase in the rate of soil loss and land degradation. At sea the change may also have a significant impact on fish and shellfish habitats and could disrupt fragile ecosystems.
We have witnessed several years of ample supply with stable-to-lowering prices. In fact, the last period of tightness among the key crops was back in early 2010 when soaring wheat prices helped trigger the Arab Spring. While global demand and supply have both risen during the past decade, the global supply chain will be left vulnerable to a sudden weather-related drop in yields.
The World Food Price Index, published monthly by the UN FAO, rose 12.5% year-on-year in December to reach a five-year high — but still sits significantly below its 2011 peak. The index, which tracks a total of 73 food commodities across five major commodity groups, saw prices rise fastest in vegetable oils (+20%) and meat (+17%).
Ample supply and weak price action have resulted in negative returns on most exchange-traded funds with broad-based exposure to key agricultural commodities. The table below highlights three of the biggest ETFs with a diversified agriculture exposure. The chart on all three shows that the decade-long downtrend is now being challenged. Of the major commodities we see sugar, coffee, cocoa and wheat being some of the most exposed to global weather scares.
Following years of rangebound trading, we see gold further building on last year’s strong 18.5% gain. This as the technical and fundamental outlook continues to improve. However, after racing higher at the beginning of January, we may see the metal spend most of the first quarter consolidating above $1500/oz before moving higher to peak at around $1625/oz later in the year. The short-term consolidation also takes into consideration the elevated level of hedge fund positions. These have become quite extended near record levels and, in the short term, could act as a drag on price.
Geopolitical events such as the early-January US-Iran standoff supported gold but only for relatively short period of time. In order for the yellow metal to climb further, one or more of our below expectations need to be met:
- The US Federal Reserve is likely to continue to cut rates while embarking on another round of quantitative easing.
- Rising inflation, through higher input cost from food and energy driving real bond yields lower. This reduces the opportunity cost associated with holding a non-coupon and non-interest paying asset.
- Continued buying by central banks looking to diversify and, for some, to reduce the dependency on the dollar (so called de-dollarisation).
- The dollar is potentially on its final leg of strength before turning lower.
- Event risks such as renewed US-China trade concerns and the November US elections.
Brent crude oil is likely to remain stuck in the $60s through the first half of 2020, before moving higher in the second. The December 6 OPEC+ decision to maintain and deepen production cuts through the first quarter is likely to offset any potential growth concerns or renewed US-China trade worries.
The mid-September drone attack on the world’s biggest processing plant in Saudi Arabia, the conflict in war-torn Libya and the early-January standoff between US and Iran all show just how vulnerable the global supply chain can be. However, with ample availability of strategic reserves in the US, China, Saudi Arabia and IEA countries the fallout from a disruption should be limited and relatively short-lived.
We see Brent crude oil at $75/b by year-end, as inflation picks up and the dollar weakens. Any short-term weakness, perhaps from speculators exciting speculative long positions, is likely to be limited. With continued threats to supply from the Middle East and Libya, the market is unlikely to reduce by much.
Outrageous Predictions 2023: The War Economy
- The constantly growing global need for energy drives the world's richest to huddle up and launch a R&D project in a size the world hasn't seen since the Manhattan Project gave the US the first atomic bomb.
French President Macron resignsThe political stalemate in France and the rise of Marie Le Pen following the 2022 elections corners President Macron, forcing him to give up on politics and resign from his position. At least for now.
Gold rockets to USD 3,000 as central banks fail on inflation mandateAs markets and central banks realise that the idea that inflation is transitory is wrong, and that prices will remain higher for longer, gold is sent through the roof, hitting a price tag of USD 3,000
EU Army forces EU down path to full unionWith continued challenges in the region and a US military that isn't aggressively enacting its former role as global policeman, the European Union agrees to create its own armed forces, bringing the whole region closer.
A country agrees to ban all meat production by 2030In an effort to become one of the global leaders on the path to net-zero emissions, one country decides to not only put a heavy tax on meat, but to ban domestic production entirely.
UK holds UnBrexit referendumFollowing a recession and domestic pressure, the United Kingdom is thrown into political turmoil that will end with a vote to wind back Brexit.
Widespread price controls are introduced to cap official inflationHistory tells us that with the war economy comes rationing and price controls. And this time is no different, as policymakers introduce strict price controls that lead to a range of unintended consequences.
OPEC+ & Chindia walk out of the IMF, agree to trade with new reserve assetSanctions against Russia have caused widespread turmoil due to US Dollar moves in countries across the globe that don't consider the US an ally. To relieve themselves from this, they leave the IMF and create a new reserve asset.
USDJPY fixed to the USD at 200 as Japan overhauls financial systemFollowing the challenges that faced the Japanese Yen in 2022, the Bank of Japan attempts to keep the currency from sliding. Unsuccessful on the long-term, Japan will launch a reset of its entire financial system.
Tax haven ban kills private equityWith the war economy comes an increased focus on national interests and sovereign nations' ability to assert themselves. In that regard, the OECD countries turn their attention on tax havens and pull the big guns out, banning them altogether.