What’s Going On With Commodities?
Some investors have been astonished by the run–up in raw material prices so far this year – after all, chocolate was not supposed to be high on the shopping list in a global recession! Well, the resurgence of commodities should not come as a surprise to Risk Watchdog’s faithful readership. My colleagues at BMI have been playing up the prospects of a commodities rally since early March, as part of their technically-driven ‘bounce theory’. Fast forward to today and prices are looking a little overcooked, but medium-term I believe there is a lot to like about commodities.
Here’s why…
• Firstly, despite the lack of global demand, commodity-specific fundamentals remain price supportive. Stocks-to-use ratios for a host of key goods are low by historical standards. This, combined with significant supply side issues for commodities such as sugar, soybean, cocoa and oil will lead to deficits in production this year, and will underpin prices.
• Secondly, risk appetite is back (albeit tentatively). If equity markets have further room to run on the upside, so do commodities.
• The majority of commodity charts look really attractive, technically speaking. The CRB index, for instance, has broken out of its downtrend, and looks ripe for some serious upside price action.
• Fourthly, step forward Beijing. The Chinese stimulus package has been a godsend for industrial metal exporters – particularly copper, aluminium and iron ore.
• Fifthly, and more recently, an out-of-sorts greenback has helped push raw materials higher, given the negative correlation between both asset classes.
Reuters-Jefferies CRB Index
Of course, where we are right now in the world (repeat after me, ‘it’s a traders’ market, not an investor’s market’) means that there are risks… Commodity markets will continue to take cues from equity markets, and therefore remain at the mercy of a market reversal. Moreover, commodity prices cannot become unaligned from the general macroeconomic picture for a sustained period of time. Supply-side constraints count for little if no one’s buying and we can’t rely on the Chinese government forever. Also, those buying into the ‘double dip’ theory should also watch out for the next potential down leg.
However, on balance, I can’t help thinking that long-term commodities exposure is a question of ‘when’ not ‘if’. With Emerging Markets expected to lead a recovery, as the West sorts out its balance sheet, demand for raw materials will inevitably rise. And I, for one, will be smiling.
***I will not be updating Risk Watchdog on Monday 25 May due to a public holiday.