Big Picture . What commodity markets can tell investors

Notwithstanding the very recent correction associated with renewed trade tensions between the US and China, a strong start to the year for the global equity and commodity markets suggest a strong macroeconomic backdrop and a high risk appetite among investors. But digging into individual commodity sectors’ performance, it is clear the situation is much more nuanced.

Oil-driven

This year, the global commodity market has been dominated by the strength of the petroleum complex. The intensity of oil-supply disruptions has largely overwhelmed middling oil demand and the seemingly perpetual expansion of US oil production, pushing Brent oil prices back up towards $75/barrel, albeit briefly. Oil-supply constraints have varied from voluntary OPEC production cuts to rising tensions among various actors in West Asia, to US sanctions on Venezuela and Iran. While additional supply disruptions are always a risk in the oil market, it is becoming more difficult to see where new disruptions may occur. Also, fading economic growth prospects in emerging markets as well as the trade spat between the US and China could put increasing pressure on oil consumption growth and energy prices.

Meanwhile, the recent retracement in industrial metals prices reflects the rekindling of the trade war between the US and China. Metals such as aluminium, nickel and copper are used extensively in production of the goods targeted by US tariffs, such as electronics. More broadly, higher tariffs also add to the existing headwinds facing the Chinese economy. But it is important to remember that Chinese authorities have the capacity to initiate significant economic stimulus should they deem the impact of the trade war too onerous for specific industries or too detrimental to the prospects for broad economic growth.

While investor and central bank interest in gold remains well above previous years’, the performance of the gold market has been meek, which is rather at odds with the more cautious view of the world economy presented by the recent weakness in the oil and metals markets. That said, there are growing signals coming from various central banks that monetary policies may become more accommodative in the second half of the year in response to flattering prospects for global economic growth which is likely to support gold prices.

The agriculture sector has been a drain on the overall performance of the commodity market over the first five months of 2019. Agriculture markets are not generally dependent on the macroeconomic environment, but a number of agricultural commodity markets, such as soyabeans, have been drawn into the US/China trade fracas. The spread of African swine fever, which will cut demand for pig-feed, and bumper harvests in North and South Americas have also contributed to soyabean prices falling to a post-financial-crisis low.

For Indian investors and policy makers, it is the global energy market that will have the greatest impact on the local economy during the second half of 2019. India has relied heavily on Iranian oil to meet a sizeable chunk of its import needs, and authorities had stated that they would wait until after the general elections to make a formal decision on whether to continue to purchase Iranian oil after the end of all sanction waivers for Iranian buyers. Even if other oil producers can make up for the loss of imports from Iran, it is doubtful whether they will offer it on attractive financial terms.

Gold demand

In the gold market, the interaction between the investment and the physical demand for gold has the potential to greatly impact the price performance of the precious metal. Physical demand in the Indian market is expected to remain relatively strong, and any further signs of turbulence in global markets are likely to encourage investors to increase the allocation to gold in their portfolios. Most global investors view gold as a safe haven asset and utilise it in their portfolios as a hedge against slowing global growth, geopolitical risks and a weaker US dollar.

The latter part of the global economic cycle is typically characterised by the outperformance of industrial commodities, namely energy and industrial metals. While commodities are not anticipatory assets, they can provide a useful insight into current macroeconomic conditions on top of any commodity-specific supply and demand dynamics. It is imperative that investors take stock of the myriad of indicators presented by commodity markets, especially given the growing economic and geopolitical turbulences.

The writer is Global Head of Commodities and Real Assets at S&P Dow Jones Indices

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