Commodities are getting interesting again. The benchmark commodity index is in a bear market, down more than 20% from its 2022 high, is this the time for bulls to jump back in?
Commodities are a diverse group of assets with sometimes wildly diverging performance. One approach to trading commodities as a group is using a commodity index.
The Bloomberg Commodities Index
The Bloomberg Commodity Index (BCOM) and the Reuters Jefferies Commodity Research Index (CRB) represent global commodity markets. The indices measure the aggregated price direction of various commodities. The CRB was the original, but the BCOM tends to gain more traction in today's markets.
Energy and metals dominate the index. Because of the outsized weightings within their respective categories, we will focus on
- Crude oil
- Natural gas
What's driving commodity prices?
Gold: Back over $2k
As the most ‘monetary’ metal, the outlook for gold depends mainly on the timing of the US Federal Reserve (Fed)'s pivot. The Fed’s dot plot showing one more 25 bps hike this year supports new all-time highs in gold.
The Fed is trying to fight off inflation and stave off a recession. As of 2023, inflation remains stubbornly high. In the US, the CPI for February was 6%, three times the 2% target of the Federal Reserve. Core inflation in the Eurozone continues to rise to new all-time highs, hitting 5.7% in February.
Should the Fed deviate from its own outlook or if inflation falls substantially, gold could turn more bearish.
Gold and silver prices tend to move in lockstep, with periods of one outperforming the other.
The gold-silver ratio rose to 95 by September 2022 but has since dropped back to 80, with silver outperforming gold over that period. If the ratio returned to 65, last reached at the start of 2021, and gold remained at $2000 per oz, silver would be $30 per oz.
Oil: Recession vs OPEC cuts
The demand side for oil has deteriorated with rising expectations for recession. The high level of inflation has eroded consumer buying power, and higher interest rates have made borrowing money difficult. This has brought about a consensus expectation that the United States will have a recession this year.
This drop in demand was arguably priced in with the near 50% pullback in crude oil futures from the 2022 peak. The latest OPEC+ production cuts and an apparent inability or unwillingness of US Shale producers to substantially increase production tightens the supply side, which has put upwards pressure on the price at the end of Q1.
NatGas: Prices dead until autumn?
Gas prices have stabilised slightly around 40-50 EUR/MWh after the dramatic rally and subsequent unwind from 2021-22. The primary test for this market will come this autumn when Europe prepares for another winter without access to Russian gas.
Copper: China's re-opening
‘Dr Copper’ tends to have a reasonable correlation with the outlook for the global economy, especially the Chinese economy. As such, it was under pressure in 2022 as China’s economy weakened but rebounded strongly after Beijing dropped the economically damaging zero-Covid policy. The outlook will rest on the strength of demand from China and the rest of Asia versus lower demand in the West, constrained by a likely recession.
Corn: Sticky food inflation
Supply chains are generally functioning again, and corn has mostly traded lower to sideways alongside most foodstuffs over the past year. A potential bullish catalyst on the demand side is China, where the economy is reopening and state-sponsored buyers can take advantage of low prices to put corn in storage.
Chart: BCOM vs CRB index
Source: FlowBank / TradingView
The chart above shows the CRB (ticker: TRJEFFCRB) and BCOM (ticker: DJP) dating back to the 2008 financial crisis. The move off the lows of 2020 appears to show a marked change in the longer-term trend from down to up. The recent price action since mid-2022 shows commodities prices correcting lower after the big move higher since March 2020. This correction either marks the beginning of a more considerable downturn or is a temporary setback before the new long-term uptrend resumes.
Higher inflation and expectations for falling interest rates mean commodities are appealing as a hard asset while the opportunity cost of having no yield is falling. The risk to this view is that central banks continue to tighten policy by raising interest. That would slow down inflation and possibly send the US economy into a recession. Should the 'hard landing' scenario play out, we could expect commodity prices to fall further, together with other risky assets.