Commodities Weekly: Weather, war and debt broaden the commodity rally

Agriculture joins the scarcity trade

Agriculture has become an increasingly important part of the rally, with soft commodities leading this week's gains while grains have also strengthened. Here, the combination of weather and war is beginning to challenge what had previously been a relatively comfortable global supply outlook.

The weather story centres increasingly on El Niño. The developing event is expected to be unusually strong, raising the risk of disruptive weather patterns across several major agricultural producing regions. Tropical crops are particularly exposed, with coffee production in Southeast Asia, cocoa in West Africa and sugar production across parts of Asia and Brazil all vulnerable to shifts in rainfall and temperature.

The impact is already visible in prices. Sugar has extended a powerful rebound amid concerns about production prospects in India and Thailand, while cocoa and coffee have also strengthened as traders reassess supply risks. The UN Food and Agriculture Organization's Food Price Index rose in July to its highest level since January 2023, with cereal prices up 3.4% during the month and sugar rising 5.6%.

The concern extends beyond crop yields. Agriculture is highly energy intensive, and the Middle East conflict has raised costs for diesel, fertiliser, transportation and irrigation. The FAO has warned that the combination of war, expensive agricultural inputs and El Niño could produce another bout of global food inflation later this year.

Grains face a different but equally important source of uncertainty. Escalating attacks around the Black Sea are disrupting one of the world's most important agricultural export corridors for wheat and sunflower oil. Ukraine recently cut its 2026/27 grain export forecast by as much as 12% following Russian attacks on its seaports, while disruption has also affected Russian export infrastructure.

In addition, Chicago corn futures have risen to an 18-month high after an industry field tour across the US Midwest suggested the corn crop is smaller than previously expected, raising concerns that yield potential may be more limited than forecast. At the same time, the tit-for-tat attacks by Russia and Ukraine on ports and vessels may ultimately force major buyers to seek alternative suppliers, potentially boosting demand and prices in other exporting regions.

The risk is therefore increasingly two-sided: weather threatens production while geopolitical disruption threatens the ability to move available crops to consumers. With energy and fertiliser costs already elevated, the margin for absorbing additional supply shocks is becoming smaller.

Bond market unease adds another dimension

The week's other major development came outside the commodity markets but may ultimately prove equally important for the hard-asset story. The US Treasury surprised markets by announcing that it would at least double the size of liquidity-support buybacks for longer-dated government bonds, increasing purchases of 10- to 30-year securities to at least USD 4 billion per operation. The announcement came after 30-year Treasury yields had climbed to 5.34%, their highest level since 2007.

Initially, the intervention worked. Long-dated bonds rallied sharply and the yield curve bull-flattened as 30-year yields fell. The dollar weakened and hard assets received another boost.

More interesting, however, was what happened next. The rally quickly faded, with 30-year yields returning towards 5.25% despite Treasury Secretary Scott Bessent subsequently stressing that the administration has a "big toolkit" available to address borrowing costs. The expanded purchases remain modest relative to a Treasury market of more than USD 32 trillion, while total US government debt has now crossed USD 40 trillion.

The Financial Times captured the sceptical market response with one investor describing the initiative as a "band-aid on a bullet hole". The underlying concern is that liquidity operations can address market functioning but do little by themselves to resolve persistent fiscal deficits, rising interest expenditure and the growing supply of government debt.

For commodities, this debate matters because it challenges one of the traditional mechanisms through which commodity rallies eventually extinguish themselves. Normally, higher commodity prices lift inflation, pushing interest rates and real yields higher, strengthening the currency and eventually slowing demand.

The question is whether large government debt burdens make that adjustment increasingly uncomfortable. If policymakers attempt to contain long-term borrowing costs while inflation remains elevated, investors may increasingly seek protection in assets whose supply cannot easily be expanded.

This does not mean monetary or fiscal policy has entered a new regime, but the market reaction this week, especially the strong rally seen across the investment metals and cryptos, suggests investors are at least asking the question. The renewed weakness in the dollar, down 1% on the week but still within the range seen during the past year, has added another tailwind, given that most internationally traded commodities are priced in US dollars.

Different commodities, common denominator

Energy remains an obvious source of physical stress as the conflict with Iran continues to disrupt Middle Eastern flows and keep refined-product markets exceptionally tight. Precious metals, meanwhile, continue to attract demand amid fiscal concerns and dollar weakness. Both themes have been covered extensively in our recent updates: When bond markets need support, hard assets start to look harder, Calm crude, tightening diesel: the real oil market stress is downstream, Copper versus gold: what an old macro signal is telling us now, and Gold holds firm as rate hike risks fade despite elevated bond yields.

What is more notable this week is how those forces are spreading across the broader commodity complex. Agriculture is responding to weather, war and higher input costs. Precious metals are responding increasingly to fiscal and currency concerns. Energy remains supported by geopolitical disruption and constrained product availability, while industrial metals continue to face longer-term supply challenges despite some near-term relief.

Copper provides a useful reminder that the story is not universally bullish. London Metal Exchange inventories are heading for their largest weekly increase since 2020 as traders deliver metal against elevated prices following months of tightness. The response demonstrates how higher prices can attract supply and eventually ease scarcity. Prices nevertheless rallied once again ahead of the weekend after China, the world's top consumer of the metal, introduced a new dose of fiscal support for the economy during one of its weakest periods in years driven by sluggish domestic demand and private spending. Measures that may support demand for commodities, including copper.

Higher prices can destroy demand, encourage substitution and accelerate new supply. A meaningful de-escalation in the Middle East or Black Sea could remove geopolitical risk premiums from energy and grains. El Niño-related concerns may ultimately prove less damaging than currently feared, while a credible US fiscal consolidation programme could reduce long-term yields, stabilise the dollar and weaken demand for hard assets.

Equally, a sharp global economic slowdown would challenge industrial commodities and energy, while persistent inflation could force central banks to maintain restrictive monetary policy for longer. Higher real yields and renewed dollar strength would be particularly important headwinds for precious metals and potentially the wider commodity complex.

For now, however, the defining feature remains breadth. The commodity rally is increasingly being supported by several independent forms of scarcity occurring simultaneously: constrained physical supply, geopolitical disruption, weather uncertainty and growing concern about the purchasing power of financial assets.

That does not guarantee prices will continue higher at the recent pace, and after a 30% year-to-date total return, the risk of corrections and profit-taking has clearly increased. But compared with earlier in the year, when performance depended heavily on a few individual markets, the current rally has developed a much broader foundation.

In a world where weather, war and debt are increasingly challenging assumptions about abundant supply and stable purchasing power, it is our opinion that commodities are once again demonstrating their distinct role within diversified portfolios, and we maintain our long-held bullish view on the sector, with some of the risks to this view mentioned above. 

This reflects a market perspective, not a recommendation. Consider independent advice before making any investment decisions.