Investors, spooked by accelerating inflation, rising geopolitical risks and mounting portfolio losses, are pushing into commodity exchange-traded funds to hedge their portfolios. This year through April, $21.4 billion has been invested in commodity ETFs, up from the $63 billion outflow in the first four months of 2021, according to Morningstar. Commodity bulls may soon regret their enthusiasm as the forces of supply and demand look set to start driving prices down soon.
Covid-19 has led to continued shutdowns in China, causing dramatic production cuts in the world’s second-largest economy, which accounts for 18.1% of global gross domestic product and 23.9% of manufacturing. The pain has spread to China’s imports of raw materials from countries such as Brazil, Chile and Australia’s oil, copper and iron ore, as well as to manufacturing exporters such as Germany, China and China. South Korea and Taiwan. According to Nomura Holdings Inc., China’s iron imports were down 13% in April from a year earlier, copper down 4% and car and chassis imports down 8%.
Russia’s invasion of Ukraine has also disrupted global demand, and the strong dollar has dampened demand for commodities from developing countries as their currencies have fallen an average of 3% since April. Of the 45 major commodities traded globally, 42 are denominated in dollars. The only exceptions are wool (Australian dollars), amber (Russian roubles) and palm oil (Malaysian ringgit). Developing economies’ commodity imports are also depressed by their growing need to use scarce foreign currencies to service dollar-denominated debts. From 2018 to 2021, Chile’s non-bank dollar debt fell from 34.7% of GDP to 50.3%, Mexico’s from 21.9% to 30.1% and Turkey’s from 23.0%. % to 28.2%.
Commodities are also suffering as economic growth favors services over goods. Since World War II, US spending on goods has fallen from 61% of its total spending to 35%, while spending on services has fallen from 38% to 65%. This is also true for developing countries like China.
On the supply side, the wind continues to face commodity prices. With the exception of brief increases during the wars and oil embargoes of the 1970s, inflation-adjusted prices have fallen steadily since the mid-1800s, by a total of 83%. Substitutes and productivity gains have always overcome threats of raw material shortages.
The devil is always in the details, but the prices of vastly different agricultural and industrial commodities often fall together since traders tend to be on the same side of the same commodity exchanges at the same time. For example, a speculator who suffers large losses on zinc positions is forced to sell wheat holdings to preserve capital, as are others.
Moreover, high prices are the best fertilizer for agricultural crops as well as other commodities. High grain prices are prompting farmers to plant fence after fence. But then bumper crops drive prices down. Similarly, high hog prices provide incentives for raising sows, especially if maize prices are low. Second, the excess supply of hogs drives down pork chop prices. Even low prices can stimulate supply. Low sugar prices encourage Brazilian farmers to plant and harvest more cane to maintain their total income.
To be sure, watch out for non-economic forces. Bad weather can dissipate heavy grain harvests. Cartels can also promote disruption. As a key example, OPEC+ actions make it difficult to forecast oil prices. Moreover, US frackers are not reacting to high crude prices by drilling more. Instead, frackers are encouraged by shareholders and their own compensation incentives to emphasize profitability. They get paid to cut costs and conserve cash to pay down debt, pay dividends and buy back stock.
In the aggressive portfolios we manage, we are selling copper futures, which are already down 14% from their peak in early March. Copper is used in nearly every manufactured product, from automobiles to machinery to appliances to computers, so it’s a great indicator of the global recession I predicted. Additionally, copper does not have a demand or supply side cartel that can disrupt fundamental economic forces. After a bleak year, rising copper prices and robust demand forecasts have, as usual, spurred new mining and refining capacity. The International Copper Study Group expects the refined copper market to have a huge surplus of 328,000 metric tons this year after a deficit of 475,000 metric tons in 2021.
Copper bulls predict exuberant demand in the coming years for electric vehicle batteries and other electric uses. But I remember when serious forecasters thought the growth of electrical distribution was limited because there wasn’t enough copper on the surface of the earth to make all the wires needed. Then came optical fibers made from silicone, the second most abundant mineral in the world. Bet on human ingenuity, not on chronic price increases due to scarcity.
More other writers at Bloomberg Opinion:
• Now even chicken is getting too expensive? : David Fickling
• Heat waves, wheat and the Chapati crisis in India: Andy Mukherjee
• The food crisis is bad; Crop insurance makes it worse: Adam Minter
This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.
Gary Shilling is president of A. Gary Shilling & Co., a consulting firm. He is the author, most recently, of “The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation,” and he may have an interest in the areas he writes about.
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