Head of Commodity Strategy
Summary: Commodities rallied strongly in 2021 with the sector recording its best year since 2000. Years of ample supply with steady prices had reduced investments towards new production and once the post-pandemic growth surge unfolded, supply was left struggling to keep up. With energy from oil to gas and coal being the main input to drive the global recovery, these sectors witnessed increased tightness which ultimately resulted in the current energy crisis.
We see another year where tight supply and inflationary pressures will support commodity returns. The decarbonisation of the world will increasingly create so-called greenflation, where rising demand and prices of commodities needed to support the process will be met by inelastic supply—partly driven by regulations such as ESG—prohibiting some investors and banks from supporting mining and drilling activities.
Overall, the energy heavy S&P GSCI Total Return Index rose 40 percent while the more broadly exposed Bloomberg Commodity Total Return index, which included a higher share of the struggling precious metal sector, managed a 27 percent return, both easily outperforming the gain of 23.3 percent in USD terms in the MSCI World Index.
Energy: The strong recovery in global energy demand together with lack of investments—partly due to regulations and the push towards raising power production from renewables—have all helped drive a surge across all fossil fuels. The outlook for 2022 points towards continued tightness and with that elevated prices. The most visible imbalance between supply and demand was seen in Europe and Asia during the second half of 2021, when gas prices in Europe at one point in December reached $60/MMBtu—more than ten times the five-year average price.
In Europe, the fragility of an energy market focused on decarbonising energy production has become increasingly apparent during the past six months. The result has been greenflation, driven by punitively high prices of gas and power prices putting heavy energy-consuming industries at risk while hurting consumers’ propensity to spend and to keep the economic recovery on track. While gas is being viewed as the bridge between coal and renewables in Europe, Asia remains stuck with coal as a key source of energy, not least in China and India where surging power demand last year was met by increased demand for coal. As a result of this and despite the need to decarbonise the world, the amount of electricity generated worldwide from coal surged by an estimated 9 percent to a new record high in 2021. The International Energy Agency estimates that demand will reach a fresh record this year, at a level where it may stay over the following two years.
While the risk of blackouts in Europe due to lack of gas has more or less been averted following a mild winter spell during the holiday period along with strong supplies of LNG, the forward price structure points to continued pain for consumers and industries across the continent. Dutch TTF gas futures for February 2023 delivery are trading only 10 percent below the current price, still more than four times the long-term average.
Crude oil markets look set to tighten further in 2022, with several producers within the OPEC+ group already struggling to meet their allocated quotas. With that in mind and considering US production struggling to reach pre-pandemic levels, we maintain a long-term bullish view on the oil market. It will be facing years of likely underinvestment with oil majors losing their appetite for big projects, partly due to an uncertain long-term outlook for oil demand, but also increasingly due to lending restrictions being put on banks and investors owing to a focus on ESG and the green transformation.
Global oil demand is not expected to peak anytime soon and that will add further pressure on spare capacity, which is already being reduced on a monthly basis, courtesy of OPEC+ production increases. According to OPEC and the IEA, the early months of 2022 could see an oversupplied market, but with spare capacity starting to run low and demand reaching a pre-pandemic peak, we see Brent crude oil reach into the $90s, and potentially above $100 during the second half.
Industrial metals rose strongly in 2021, but with most of the 32 percent jump in the London Metal Exchange Index occurring during the first half, the year ended with some degree of uncertainty. After hitting a record high in May, copper spent the remainder of the year trading sideways on continued worries about the outlook for the Chinese economy, especially its troubled property sector. Aluminium, one of the most energy-intensive metals to produce, also rose strongly in 2021, and the outlook remains supportive with supply disruptions at the end of 2021. This adds further fuel to expectations of a growing supply deficit this year, not least considering the outlook for slowing capacity growth in China as the government steps up its efforts to combat pollution, and ex-China producers for the same reasons being very reluctant to invest in new capacity.
While the energy transformation towards a less carbon-intensive future is expected to generate strong and rising demand for many key metals, the outlook for China is currently the major unknown, especially for copper where a sizeable portion of Chinese demand relates to the property sector. But considering a weak pipeline of new mining supply we believe the current macro headwinds from China’s property slowdown will begin to moderate through the early part of 2022.
This is supported by the prospect of the PBOC and the government—as opposed to the US Federal Reserve—stimulating the economy, especially with the focus on green transformation initiatives that will require industrial metals. With inventories of both copper and aluminium already running low, development could, in our opinion, be the trigger that sends prices back towards—and potentially above—the record levels seen last year. Months of sideways price action has cut the speculative length, thereby raising the prospect for renewed buying once the technical outlook improves; in HG copper that signal would likely be triggered on a break above $4.50 per pound.
Precious metals was the only sector suffering declines last year, but considering the headwinds from rising bond yields and a stronger dollar, gold’s negative performance of around 3.6 percent was acceptable from a diversified portfolio perspective. Being the most dollar- and interest rate-sensitive of all commodities, gold will take some—but not all—of its directional inspiration from these two markets. Gold is often used by fund manages as a protection against unexpected events, whether they are macroeconomic or geopolitical developments. The wall of money provided by governments and central banks following the first wave of the Covid-19 outbreak helped reduce macroeconomic risks, while sending the stock market sharply higher.
Just like in 2021, gold has started the year on the defensive and once again the early weakness was driven by surging bond yields, after the US Federal Reserved signalled it would step up its efforts to combat inflation. During the first week of trading US ten-year real yields surged higher by 0.3 percent, but instead of responding with a sharp selloff as seen during similar periods last year, gold managed to hang on to $1800/oz, a level around which the market traded for a considerable amount of time during the latter part of 2021.
Into the early part of 2022 gold looks stuck within a wide $1740 to $1860 range. Key to the short-term direction is how it balances the opposite pulls from the potential risk of yields surging higher against raised market uncertainty, and the dollar which may struggle to replicate last year’s strong performance. However, with the market already pricing in close to four rate hikes in 2022 with the first one pencilled in for March, and inflation already running above 7 percent, we question how much worse, from a gold pricing perspective, data and expectations can get in the short term.
With this in mind and considering continued robust EM and central bank we maintain a bullish outlook for gold—and potentially even more so for silver—once industrial metals, as expected, resume their rally. The expected rally to a fresh high may however be centred around the second half, especially if, as John Hardy says in his FX Outlook, the Federal Reserve continues to hike rates until things break.
Agriculture: The UN FAO’s Global Food Price index ended 2021 showing an annual increase of 23 percent, with the sugar and vegetable oil sectors seeing the strongest rises. While we see some moderation in 2022, climate and weather risks remain a concern at a time when supplies have been tightening. Adding to this is a gas-related surge in fertiliser prices which—together with higher fuel costs—may drive a move towards crops with a lower fertiliser intensity.
Crops with the biggest upside potential are those supporting growth in renewable fuels, such as corn, soybean oil and sugar, especially considering the prospect of higher oil prices amid capped production. In addition, Arabica coffee—already trading at a ten-year high—may rise further if expectations for an adverse weather-related slump in Brazil’s production come to fruition over the coming months.
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Uncover the shifting focus in 2024's FX markets towards growth resilience and relativity, away from bond yields and inflation stories.
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The disheartening cycle of unresolved geopolitical conflicts, the rise of polarizing political parties, and the stagnation of productivity.
Understand China's political landscape in Q4 2023 and the impact on counter-cyclical initiatives, with a focus on the pivotal Q1 2024.