Best year start for commodities since 1973
Commodities are not a structural asset class, because there is no structural risk premium on commodities. In fact, the risk premium is probably negative, because innovation and productivity gains put structural pressure on commodity prices. Nevertheless, a new supercycle in commodities started a year ago. The main reason to expect higher commodity prices was the low level of commodity prices then. A year ago, they were at their lowest level since the 1970s, the oil price was even negative for a while. Since then, commodity prices have risen by 85% in dollar terms according to the S&P GSCI index. In euro terms, commodity prices have doubled.
The premium for commodities that can be delivered now versus commodities that will be delivered in the future has not been this high since 2007. This is a strong signal that there is a lot of demand and/or little supply. The futures curve for commodity futures has not been this inverse since 2007; the market is in backwardation. There is a positive base, which means that all other things being equal, a positive roll-over return can be made, simply by the passage of time. So it pays to invest in commodities.
The reason for the imbalance between supply and demand is primarily the corona crisis. Many commodity producers assumed that there would be a recession with a lot of drops in demand. That recession came, was deep, but also short. Moreover, consumer spending shifted from services (holidays, hospitality, etc), to products (renovations, electronics etc). Nowhere is the pig cycle as long as in the production of raw materials. It takes many years before a mine comes into production, or before oil can be produced. So we have to be patient. Furthermore, some structural trends create a strong demand for raw materials. The energy transition is putting heavy demands on metals, including copper.
Furthermore, global consumption will double over the next decade as a result of the emerging middle class in Asia. Nearly 90 percent of this doubling is accounted for by this region. It is a mix of urbanisation, population growth, and strong economic growth that is adding hundreds of millions of consumers with purchasing power. All people who want a house, a fridge, a PC, a car and, if possible, holidays too. With the energy transition, there is also a clear trend towards sustainability. That probably means much higher environmental requirements in the production of metals and fossil fuels, and that raises prices. The price of CO2 has already risen sharply, but it would have to double or triple again to have any real effect. In that respect, CO2 rights are a nice alternative within raw materials.
The influence of the changing climate on commodity prices is also growing. We all remember the images of the cold snap in Texas, but that also caused the price of soy beans to rise to the highest level in seven years. In Brazil, the weather is too dry. This does not only mean lower yields, it also means that many raw materials cannot be transported over water. The most important raw material is still the oil price. It influences other commodity prices because, for example, the production of agricultural commodities requires a lot of energy, not only for machines that work the land but also in the form of fertilisers. As a result, 60 to 70 percent of food consists of energy. Much energy is also needed to mine and refine metals. The oil demand seems to be rising again to pre-Covid levels. In China, the demand for fossil fuels is already higher than before the corona crisis. The scale of alternative energy is still too small to meet this demand. Moreover, Texas has shown that a complete switch to alternative fuels is not without risks either. The Biden administration has come up with an extensive infrastructure plan, something that will undoubtedly require a lot of raw materials. The entire Western world needs to catch up in terms of basic infrastructure in the areas of electricity, water, and sewage, all things that consume raw materials.
Two raw materials are worth mentioning in the context of sustainability. The first has already been mentioned and that is CO2. During the tortilla crisis, investors were blamed for driving up the prices of corn and other commodities because of the high demand for commodity investments at the time. Driving up CO2 prices actually has a positive social impact. It accelerates the energy transition. The second commodity that is interesting is wood. As is well known, commodity investors do not receive coupons or dividends, but wood is the only commodity that increases in value every year, simply by growing. In addition, wood is an excellent way of sequestering CO2, an additional advantage if houses are made of wood in the future.
Gradually, supply and demand on the raw materials market will come into balance, but later in the decade, the aforementioned structural developments will have an increasingly positive influence on the price of raw materials. Between the bottom and the top of a typical commodity super-cycle, there is easily a period of seven to ten years. The remarkable thing is that the higher commodity prices are hardly reflected in the inflation figures, but we will talk about that next time.