COMMODITY OVERVIEW – China, Russia, Rates, Inflation
Commodity markets are continuing to be impacted by the four major factors that are spooking investors – China, Russia, Rates, Inflation – and it’s the coalescing of these factors that have made such an immediate and significant impact on commodity markets and equity prices.
In China, we’ve seen the ongoing impacts of the COVID-19 shutdown impacting demand for battery material commodities – in particular cobalt, nickel, and lithium – via the disruption of transportation and a reduction in battery manufacturing. Some producers of battery materials have slashed production by 15-40%. But despite current difficulties, demand for the minerals is expected to recover during H2 2022 because factory activity will gradually return, and most vehicle producers are maintaining annual production targets.
REASONS FOR OPTIMISM
And whilst we can expect further significant volatility, I believe there’s cause for optimism in the second half of 2022.
Firstly, commodity prices are well above their covid lows, above the levels prior to the Russia-Ukraine conflict, and are above 2021 average price levels. So, what we are seeing is a situation where commodities are consolidating at higher levels, despite volatility.
The longer-term picture for battery and industrial materials remains largely intact and even from a short-term perspective there is cause for optimism, with the prospect of a recovery in China commodity demand during H2 2022, led by additional government stimulus for the construction sector. China is typically a big buyer of commodities in the latter stages of the calendar year, as it looks to restock inventories.
Supply-side considerations are also providing a robust level of support for metal prices, and it’s not just supply impacted from Russia or Ukraine. It’s China too, where the ongoing lockdowns will act to restrict the supply of commodities, as China represents the world’s largest producer of metals, which will help provide further price support over the coming months. More broadly, the world’s biggest copper producers have continued to report lower output, with Peru – the second biggest producer in the world – saying that production in March fell year on year, similar to the situation Chile – the world’s biggest producer – reported last week.
One of the other factors that are indirectly impacting commodity prices in a negative way has been the tightening of monetary policy by the US Federal Reserve, which has led to a rising US Dollar Index that’s at a 20-year high, making commodities more expensive to buy in terms other currencies (as metals are quoted in US dollars), impacting demand in other currencies. However, commodities remain a sought after hedge against inflation, which should offset to some degree the negative impact of the rising dollar.
Gold is putting up a brave fight in the face of the double-whammy of the US dollar hitting a two-decade high and rising US Treasury yields – which are both negatives for bullion. The metal has been sliding since mid-April, as the Federal Reserve and other central banks tighten policy to fight rising consumer prices. The monetary squeeze has sent yields on US government bonds past 3% and has fuelled five weeks of gains for the dollar, making gold less attractive. Still, there could be more bond market swings to come, as a swathe of inflation data feeds the debate on price pressures and monetary policy.
I believe that gold’s downside is limited due to ongoing concerns relating to China, Russia, inflation and interest rates.
It’s also interesting to compare the recent performances of both gold and Bitcoin as inflationary hedges. Both gold (traditionally) and Bitcoin (recently) are seen as a way to diversify a portfolio as well as a hedge against inflation and fiat currency debasement. However, as Bitcoin has continued to extend its losses, dropping below $32,000 for the first time since July 2021 and thus taking its losses from its November record high to more than 50%, it’s interesting to compare its performance versus gold. Bitcoin’s performance over the past 12 months is suffering as investors look for genuine havens against inflation, such as commodities and gold.