Shallow copper correction in Q1 highlights underlying strength
Key commodities from crude oil to copper and iron ore started 2023 with strong gains in the belief that a post-pandemic recovery in China, the world's top consumer of raw materials, would more than offset darkening economic clouds elsewhere, not least in Europe, still reeling from last year’s energy crisis, and the US, where the Federal Reserve in their attempt to combat inflation continued to hike rates at the fastest pace in decades.
As the quarter matured, it became increasingly clear, however, that the growth impulse from the Chinese reopening was not developing strongly enough to offset the negative impact of rising rates, especially after Fed Chair Powell’s “whatever it takes” message to the market. The market could see this as recession by design, i.e. the Fed prepared to take aggressive action in order to cool inflation, no matter the economic impact, meaning higher rates and for much longer than previously anticipated.
Despite promising signs of the recovery in China, growth-dependent commodities nevertheless traded softer throughout the remainder of the quarter, before tumbling further, following the emergence of a banking crisis. However, while crude oil slumped following months of rangebound trading, the damage inflicted on China and industrial metals associated with the green transformation was limited, and precious metals rallied as bond yields slumped and the Fed softened its tone, with the timing of peak rates suddenly moving closer.
Ahead of the second quarter, most commodity sectors are showing year-on-year declines, driven by economic growth worries and partly because of the strong rally this time last year that followed Russia’s invasion of Ukraine. Hardest hit are the growth and demand dependent sectors like energy and industrial metals, both currently showing a yearly decline around 25%; the agriculture sector is down 6% primarily due to steep declines in wheat and cotton, while precious metals, following the March turmoil, found support to trade flat on the year.
The result being an easing of the across-market tightness that was very present last year, and which helped drive strong investor returns, but not to the extent one would expect, given current growth concerns. Out of the 12 major commodity futures tracked by the Bloomberg Commodity Index and with an index weight of more than 2.5%, only four show a one-year price spread in contango, which is usually characteristic of an oversupplied market where the spot price trades below the one year forward price.
The conclusion is that the long-term upside potential for commodities has not died a sudden death and will continue to be driven by tightening supply conditions for several key commodities, caused by lack of investments (and not improved by the current banking crisis), the China recovery story, global policy support for the energy transition, an infrastructure rebound as well as increasingly volatile weather risks.