Commodities recovery poised to continue

Ben Ross

Head of Commodities

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Nick Koutsoftas

Portfolio Manager, Commodities

More by this author

11 minute read

June 2021

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After a decade-long bear market, commodities are showing signs of life. We see further upside potential despite significant repricing from pandemic lows, driven by a supportive macro backdrop, attractive fundamentals and growing investor demand for inflation-sensitive assets.

  • Global GDP growth in 2021 is expected to be the highest in decades as the pandemic downscales and economies reopen, boosting demand for raw commodities.
  • Supply/demand fundamentals for many commodities appear the most attractive in almost a decade according to our analysis, which we believe are likely to persist.
  • Commodities have historically been one of the best ways to hedge against unexpected inflation, typically experiencing significant outperformance when inflation surprises on the upside.

Commodity prices continue to set records across a wide swath of sectors

The Bloomberg Commodity Spot Index climbed to a 10-year high in May following broad-based participation in the rally. Surging industrial usage, increasingly from green technologies, drove copper to an all-time high. Palladium began the month at a record high above $3,000 per ounce before consolidating a portion of its earlier gains. Grains touched their highest levels in more than eight years. Lean hog prices have nearly doubled this year and stand at their highest level since 2014 as a second wave of African swine fever in China has resulted in a decline in the herd population. While still far from its record, West Texas Intermediate crude oil has returned to 2018 price levels as producers have maintained supply discipline in the face of rising energy consumption.

Macroeconomic conditions remain highly constructive for commodities

The synchronized global recovery behind the demand push is being aided by $25 trillion in planned fiscal and monetary stimulus globally. In particular, China (a major consumer of commodities) is expected to grow close to 8.5% in 2021 despite recent policy normalization, further bolstering the synchronized global recovery. We believe the potential for a lasting economic recovery and above-trend global growth bodes well for an extended period of strong commodity consumption.

Supply/demand imbalances likely to persist

Our analysis suggests that fundamentals for many commodities are the most attractive in almost a decade. Inventories for most commodities were at multi-year lows before the pandemic hit, leaving producers scrambling to meet the now surging demand as economies reopen. A lack of investment in supply in recent years means ramping up output will take time. Also, COVID-related production issues and supply chain constraints that plagued many sectors during the pandemic, (particularly metals), are still lingering. For grains and softs, the weather has also played a major part in the price moves this year, with La Niña–induced droughts in Argentina, Brazil and the United States severely impacting production.

2021 inventory estimates are below their respective 10-year peaks and averages for most commodities.

Supply shortage

Estimated inventory

Sector views

Energy: Rebalancing likely to keep upward pressure on petroleum prices. Inventories within the 38-country Organization for Economic Cooperation and Development are now below their five-year average, and a significant deficit is forecasted for the second half of 2021, driven by strong global demand growth and expectations of OPEC+ output growing only modestly. This may keep Brent crude above $70 per barrel over the next 12 months. We are now slightly underweight natural gas, with the recent price move likely fully discounting current shoulder month fundamentals, in our opinion. However, our longer-term view remains constructive, driven by stabilizing U.S. production, strong liquid natural gas exports and growing power generation demand.

Industrial metals: Cautious, with prices well above pre-COVID levels. There are indications that high prices have started to reduce purchasing by key Chinese metal consumers, and the government has implemented measures to curb speculation on their exchanges. In addition, the second half of the year should see increased nickel and zinc supplies, which may coincide with a demand slowdown. We prefer copper for its relatively tighter forward balances and its demand linkage to the green energy revolution.

Softs: Mixed outlook, with a favorable view of coffee. We believe the market has not yet fully discounted the magnitude of the upcoming Brazilian coffee crop disappointment. Additionally, coffee producers may need to buy back previous hedges in the face of soaring prices and lower-than-expected production, putting further upward pressure on prices. We are bullish on cotton’s prospects and continue to forecast that U.S. acreage will ultimately fall below current market expectations due to rising prices for competing crops, such as corn and soybeans. We remain bearish on sugar, as favorable production economics will likely keep the 2021/2022 Brazilian crushing season tilted toward sugar yet again.

Grains: Declining inventories expected in corn, soybeans and wheat. We favor corn and soybeans on a medium-term basis, as U.S. stocks-to-use are on pace to hit their lowest level in nearly a decade at the end of the 2020/21 marketing year (and will likely stay there in the 2021/22 marketing year given strong export and biofuel demand). Prices will need to rise further to defer demand until after the 2021 U.S. harvest and to incentivize southern hemisphere farmers to expand their plantings in the second half of 2021. However, the near term is fraught with risks, ranging from favorable early-season crop condition ratings to potential stocks and acreage surprises in the USDA’s Grain Stocks and Acreage reports (which are due out at the end of the month). We continue to favor soybean oil over soybean meal, as the demand outlook for renewable diesel and biodiesel remains rosier than that for U.S. and global protein feed demand.

Precious metals: Tempering our outlook given potential upward pressure on real yields. We believe the reopening U.S. economy and the improving labor market will translate into upward pressure on inflation-adjusted yields, which suggests a limited upside for gold. This same dynamic applies to silver, albeit to a lesser extent given its industrial demand and leverage to green energy spending.

Livestock: Elevated supplies of cattle-on-feed likely to keep pressure on prices in the near term. Large placements during the fall of 2020, combined with drought-induced placements this spring, may keep the market well supplied in the near term. Longer term, a smaller calf crop in 2020 (due to poor cow-calf producer economics) may result in lower slaughter and beef production into 2022; a contraction in the cattle herd has historically been supportive for cattle prices. For hogs, we believe the market has overestimated the U.S. herd size and the backlog of animals resulting from meatpacking plant closures in 2020. However, while we think fundamentals for the U.S. hog market are on a solid footing, valuations appear to be extremely stretched and herd-building in China poses a potential risk.

Attractive portfolio benefits driving investor interest

  • Inflation hedging: Commodities’ historical sensitivity to unexpected inflation demonstrates their potential to serve as an effective inflation hedge. An inflation beta of 9.2 for commodities since 1991 (see below) is the highest among listed real assets, indicating that commodities typically outperformed their long-run average by 9.2% for every 1% that realized inflation exceeded the prior-year estimate.
  • Diversification potential: Commodities historically have had a low beta to global stocks (0.43 over the post-1991 period represented in the exhibit below), adding to potential diversification benefits beyond inflation sensitivity.
  • Relative value: Commodity valuations relative to both stocks and bonds are at their lowest points in at least 30 years at a time when many financial assets are richly priced.

Commodities have historically been one of the best hedges against unexpected inflation.

Inflation defense

Beta to inflation surprise (y/y realized vs. expected), 5/1991–3/2021

Closing thoughts

After a challenging decade for commodities, we see potential for a sustained, multi-year, broad-based rally, driven by three key factors:

  • A highly supportive macroeconomic backdrop
  • The strongest supply/demand fundamentals in a decade
  • Attractive portfolio benefits—including inflation sensitivity—driving speculative inflows

For more information about the role commodities can play in a diversified real assets portfolio, please contact your Cohen & Steers representative or read our latest insight on building inflation-resilient portfolios.

ABOUT THE AUTHORS
Author Profile Picture

Ben Ross, Senior Vice President, is Head of Commodities and a portfolio manager for Cohen & Steers’ commodities strategy.

Author Profile Picture

Nick Koutsoftas, Senior Vice President, is a portfolio manager for Cohen & Steers’ commodities strategy.

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