WisdomTree ETF: Although commodities as a group pulled back 1.1% last month, it was mainly on the back of natural gas and aluminium prices dropping.
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The big picture
- Both commodities had astronomical gains earlier in the year and are still up 88% and 35% respectively over the past year.
- We believe that the current elevated inflation environment will be positive for the commodity complex. US consumer price index (CPI) inflation rose 6.2% in October 2021, marking the highest level of inflation since 1990. We believe that supply-side shocks are both larger and more persistent than the market had expected. Tell-tale signs of supply bottlenecks are littered through the details, including elevated energy and autos prices.
- Commodities are uniquely well-positioned to hedge against unexpected inflation, with the strongest inflation beta of all major asset classes. If the drivers of inflation today are unexpected, then commodities are the place to turn to.
- We believe the US dollar is appreciating as markets are expecting the Federal Reserve to be pressured to act faster on inflation given the recent surprises. If the Federal Reserve is able to raise rates faster than other central banks, it will increase their interest rate differentials and thus be dollar positive. US dollar strength is normally negative for commodities, but the extent of inflation strength, especially from unexpected sources, may support the complex.
- Other short-term risks to commodities include visible slowing down of growth in China. However, we expect any pullback in commodity demand to be temporary in nature and therefore great entry points into the commodity market which is likely to see strong medium-term growth on the back of improving infrastructure demand elsewhere around the globe and an energy transition that will be particularly supportive for base metals and constrain hydrocarbon production.
A glance at the sectors
Precious metals:
Precious metals were the strongest commodity sector last month and were up 4% with positive contributions coming from across the basket.
Gold was up 3.2% over the reporting period. The precious metal’s fortunes appear to have been revived in October, and November has started on a positive note.
The response from the rest of the precious metals complex has been exactly as expected. The more ‘precious’ the metal, the higher the correlation with gold, and more immediate the price response to gold. Gains in silver and platinum have coincided with gold since October although the price movement, over our reporting period, was even more pronounced for the two compared to gold. This rings true to the property of silver and platinum of offering a leveraged play on gold. Silver was up 7% while platinum was up 7.9% over the period.
But the fates of platinum, and its close associate palladium, are inextricably tied to the automobile industry. The car industry, which uses platinum and palladium as autocatalysts for reducing vehicle emissions, continues to face challenges in sourcing semiconductors. With sentiment (and price) hit quite hard since the second quarter of this year, the slightest reprieve can appear significant. In the meantime, however, gold may be doing the heavy lifting for the entire sector.
Industrial Metals:
Industrial metals were down 0.6% last month with largely aluminium to blame given performance was positive across the remaining commodities in the sector.
Aluminium was the lone, yet significant, detractor in a group that otherwise delivered strong performance. The metal has been on a strong run since the start of the year as China has reduced its supply to decarbonise its aluminium industry. In October, however, China increased its coal supply to ease some of the short-term pressures facing the energy sector. Given the aluminium industry still relies very heavily on coal and the decarbonise will likely take years, markets expect this move to ease some of the immediate tightness in aluminium markets. Based on current trends, the aluminium market is expected to remain undersupplied in 2022.
Zinc, on the other hand, presented a contrasting picture last month making gains of 7.6%. October was a month of two halves for zinc. The metal was particularly volatile as prices rose sharply when European producer Nyrstar announced on 13 October that it would cut zinc production by 50% at three European smelters due to the surge in energy prices. This exacerbated concerns of an already tight zinc market given production cuts in China. And even though prices retreated in the second half of the month as concerns around energy market tightness eased, zinc still finished the month up overall.
Energy:
Energy sector was down 4.5% over the period.
Following months of an extremely strong natural gas rally, US natural gas prices trimmed 13% last month. Natural gas production in the US is now making up for losses during the Hurricane Ida disruption earlier this year and Russian promises to provide Europe with more natural gas have taken the pressure off US exports to the European market. In turn, the premium on US natural gas to supply this market has come off. However, if Russia fails to live up to its promises, or if Europe experiences a sudden cold snap, US prices could easily rally once again.
The US Energy Information Administration and the International Energy Agency still paint a positive picture for the oil markets, with demand outstripping supply in 2022, so long as OPEC+ don’t abruptly increase supply more than currently planned. While both agencies suggest that global supply shortages in other energy sources will drive higher oil demand for power production, we believe this argument is finely balanced as elevated oil prices can become demand destructive after some time.
The backwardation in both Brent and WTI futures curves indicate market tightness in the crude oil. Investors in rolling future strategies clearly benefit from positive roll yields in these markets and these roles have strengthened in the past month.
Agriculture:
Agriculture sector was up 1.3% over the period.
Coffee prices rose 6.1% last month. Columbia, the second biggest coffee producer, has slashed production estimates for this season’s crop by 7% owing to excessive rains caused by La Nina which are hurting yields. Rising production costs could also result in reduced crops of high-end coffee beans.
Lower stocks in major export countries such as US, Canada and Russia are lending a tailwind to wheat prices. Added to that, the prospect for next year’s crops is also deteriorating. The US Department of Agriculture (USDA) has rated the proportion of winter wheat plants as being in good or excellent condition at only 45%. The dry weather has also led to delays in planting in Russia and Ukraine. At the same time, demand remains robust despite the higher wheat prices.
Cotton’s price rally is being driven by unfavourable weather events in the key US growing areas coupled with strong demand from China. Added to that, rising crude oil prices are making synthetic fibres more expensive than cotton. The USDA estimates a global supply deficit of 4.6mn bales for the 2021/22 crop year after a deficit of more than 7mn bales in the previous crop year. Demand has now recovered from its pandemic-related slump in 2019/20 and is expected to exceed its pre-crisis level this year.
Source: All data sourced from Bloomberg as of 05 November 2021
Source: ETFWorld.co.uk
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