Head of Commodity Strategy
Summary: Led by industrial metals, the commodity sector is currently going through a correction. Following a record run in Q1 such a move was long overdue with the main catalyst being driven by China and its no tolerance policy towards Covid-19. In addition, a combative US central bank driving up funding cost and a much stronger dollar together with signs of a global slowdown caused by inflation at the highest level in decades have all helped raised some doubt about the outlook for demand. In this we take a closer look at copper and why we maintain a positive price outlook.
The commodity sector is currently going through a correction, and after witnessing a record run higher during the first quarter, such a move was long overdue. The main catalyst for the weakness has undoubtedly been driven by China and the no tolerance policy towards Covid-19, where outbreaks in Shanghai and Beijing have been met with a prolonged period of lockdowns which has hurt economic growth while creating major bottlenecks across global supply chains.
In addition, a combative US central bank driving up funding cost and a much stronger dollar together with signs of a global slowdown caused by inflation at the highest level in decades have all helped raised some doubt about the outlook for demand. We have in recent updates and webinars highlighted the need, not only to focus on demand but also the supply side when trying to determine the outlook for the commodity sector.
While demand may show signs of easing, the supply side looks equally challenged across several key commodities, spanning from energy to industrial metals and agriculture products. Developments that in our mind may prevent prices from a much needed deep correction in order to ease global price pressures.
Example: WisdomTree Industrial Metals, a UCITS eligible ETC (Exchange Traded Commodities) tracks the Bloomberg Industrial Metals Total Return Index.
As mentioned, much of the slowing growth focus has so been directed at China, the world’s biggest importer and consumer of raw materials, especially after an initial and failed attempt in late March to prevent the virus from spreading from parts of Shanghai. Six weeks later and the Covid outbreaks in China and restrictions intended to contain them have indirectly added to operating costs, making it tougher for factories to maintain production, obtain raw materials and ship out finished goods.
Industrial metals, the most China-centric commodity sector has suffered the most from these developments with the Bloomberg Industrial Metals index having fallen by close to 25% since the March 7 record peak. Other sectors like precious metals (-12%), energy (-10%), grains (-5%) and softs (-6%) have seen smaller declines from their recent peaks. With the industrial metal sector having almost reversed back to levels seen at the start of the year, the question remains what may support an eventual floor under the market. The simple answer is China.
China’s current situation was recently described by a major investor in Hong Kong as the worst in 30 years with Beijing’s increasingly fraught zero-Covid policies slowing growth while raising discontent among the population. As a result, global supply chains continue to be challenged with congestions at Chinese ports building, while demand for key commodities from crude oil to industrial metals have seen a clear drop. One of the consequences being the need for the government to launch a major stimulus drive to support a recovery in growth, currently well below the 5.5% target. Such initiatives are likely to support the industrial metal sector given the focus on infrastructure and energy transition, hence our view that following the recent weakness a floor is not far away.
A renewed pickup in demand for industrial metals from China will once again expose the precarious low level of available inventories. Adding to this the government supported energy transition, especially in Europe where getting rid of dependency on Russian energy supplies have become a major focus, and the market may quickly turn its focus from demand to tight supply. Inventories of key industrial metals from aluminum and copper to nickel and zinc at exchange monitored warehouses are at multi-year low levels, and with additional supply not easily accompliced, a tight supply outlook may help support the sector finding a floor and move higher.
As an example, the recent loss of momentum and China focus has seen the HG copper contract slump to the lower end of its year-long trading range, and in the process speculators have flipped their position back to a net short for the first time in two years. A bounce from current levels without challenging key support towards $4 per pound may trigger an initial short-covering move from recently established short positions.
Our bullish view on industrial metals have not changed, but given the risk of weaker economic growth ahead we do not expect a fresh runaway rally. Instead we see steadily higher prices driven by tight supply, China growth initiatives and the green energy transformation.
The below table highlights some of the major mining companies involved in copper production. The top six derives more than 60% of their revenues from copper, and the recent correction, driven by general stock market weakness and lower copper prices, have seen these stocks drop between 25% and 48%.
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