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Are commodity markets setting up for a defining year?

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Commodity markets are entering a very interesting phase this year. Long term we have seen massive underinvestment in vital minerals (like copper, iron ore and nickel). Combine this with the “greenification” of our energy supply and transportation, and the demand for these commodities could very well capture the market on the wrong leg and be the catalyst for a whole group of metals to move, since official energy and climate policies are way behind the curve.

Medium term, the wobbles from the demand and supply issues that Covid19 has created are still being felt and could end up having a long term impact on commodity prices, since supply chains will have to warehouse more inventory. The optimization process employed with supply chains, by making them thinner (not leaner), is probably over and now and will be reversed in terms of the quantity of commodities that now needs to be warehoused. This too will affect prices.

Outside that, we have new/other metals that will become more relevant through new and smarter alloys in the future, plus the EV-metals that will become very relevant in the very near future, much faster than people think and supply chains (mines getting online) can react to.

Materials science will bring forward the next revolutionising step, as did simple iron to steel before, not only for smart steels/alloys and the coming “super steels and alloys” in the future; battery chemistries will also revolutionise our ability to store and manage energy and fast. This will bring, and already has, fantastic investment opportunities now as well going forward.

Agricultural commodities

Solar activity, the El Nino and La Nina cycles as well as climate change are currently all supportive of higher agriculture prices.

We could be about to see a situation where external factors together with underinvestment in commodities production over the last 10-30 years could end up producing the perfect storm for commodity prices. That combined with my own conviction, that inflation will be nurtured by the central banks, as a “slow default”, produces an overall positive outlook for many commodities through the next 10 years (and maybe longer), and should make them a consideration for all financing and investment portfolios. Commodities and their related stocks probably provide the best hedge against rising and normalised yields, which we have seen accelerate the last weeks.

Speaking of the central banks, the “slow default” seems to be the only way out of the current debt situation which most major economies have established for themselves over the last 20 years and has accelerated after the GFC and again after the recent Covid19 crisis.

ThomsonReuters CRB index - Monthly
ThomsonReuters CRB index – Monthly

Copper

Copper (and partially steel) is the metal of society and infrastructure, has been relevant for more than 10.000 years and will become even more relevant over the next 20-30 years, where transport energy production, distribution, and usage will see as many changes as they have seen over the prior 200-300 years. This will be driven by the ‘greenification’ of our energy supplies as well as the major infrastructure build requirements this will require around the world.

Copper reserves and mining grades have been depleted over many years, and this combined with low expenditures on exploration and the development of new mines gives an interesting and bullish outlook for copper.

With the energy and mobility transition that we are expected to go through in the next 20 years, that demand outlook can become even more interesting. The general demand side can be delayed by a recession, because copper is very cyclical and positively correlated to global growth outlooks, and so one must be aware of that on portfolio risk level.

The technical side of things looks quite interesting for copper, currently the charts indicate that copper could break up through its All Time High just below 5 USD/Lbs and that will open the window for a permanent lift of copper prices towards 7 USD/Lbs longer term. A rise away from the 4 USD level towards 5.50 USD, which does not sound like much, will have a huge impact on the pricing of copper stocks of all kinds, and certainly ignite M&A activity from the major miners and rising Chinese resource companies.

Copper - Weekly chart
Copper – Weekly chart

An interesting aspect here is: will the automotive industry once again let the energy side of their equation escape them? They missed their chance the last time, 100 to years ago, and remember, the oil companies became much larger than the automotive industry. This observation not only is relevant for copper, but especially for the battery metals like lithium, nickel, manganese and graphite. And these metals are also a thought worth in regards to mining and resource investments.

Medium term caution

But I would be cautious on copper over the medium term. Copper has already gone a very long way since its bottom from the march 2020 Covid reaction into 1.98 USD. The economic backdrop is “tricky” overall, macro wise, but bullish inputs from the upcoming infrastructure projects and the new EV demand. plus general supply side issues are certainly there.

Investors must not forget that copper is a very cyclical asset, trouble in stock markets has the potential to migrate into copper prices and outlooks.

Copper - Monthly chart
Copper – Monthly chart

The gold market: still relevant?

Gold has been a currency and storage of value for thousands of years, and the big question is, will it remain that way in the future? We have seen heavy competition from crypto currencies, especially Bitcoin over the last 10 years. Is crypto really a source of competition, substitution or just a supplement to gold? That is the real big question, since demand for gold has really come from the central banks in the later years.

Culturally, new demand for gold should arise from the Asian population’s rising wealth. Assuming that gold keeps its relevance, the fundamental outlook seems good, just like with most other metals, especially with the grim outlook on inflation and my expected negative real yields policy from the central banks. That normally serves as a very strong backdrop for rising gold prices. But somehow it needs someone to market the metal, else it could turn into a relic for old men (and women).

Commodity stocks will reward investors

The current very high inflation numbers will not be permanent, but they will probably not be transitory either. A probable scenario is that we will return to the 3% long term average in the US, which could undershoot in some years because of innovation.

But no matter what outlook one believes in, I feel investors will be rewarded by allocating into commodities broadly and their related companies. At worst, commodities and related companies will provide a cheap hedge against investors “duration ” and “USD” risk (that may not materialise) in their portfolios.

And at best, commodities could be some of the best performing sectors in the coming decade. Consideration should still be made towards jurisdictions, favourable locations, and strategies when it comes to investing in commodity stocks. I personally like commodity stocks which have a low footprint and impact as well as good infrastructure, furthermore I want to see visible triggers on the nearer term horizon. Value is certainly there in the commodity stock sector, and some stocks are very cheap. But nobody can guarantee this will change.

Manufacturing commodities have had low prices, probably to low, for a long time. But as an investor one should remember, that the solution to low prices – are low prices! Underinvestment in new supply will eventually lead to higher prices. Therefore, it seems quite clear that the conditions for rising resource prices in the coming years are well in place.

Capital has been allocated elsewhere in the last 30 years generally, and the shifting winds of demand could very well bring forward continued high commodity prices, if we do not enter a longer recession that will starve out demand for cyclical commodities, in which case gold will be the best performing metal.

Henrik Mikkelsen is an investment strategist with Iridis AG in Switzerland.

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This article does not constitute investment advice. Make sure you do your own research or consult a professional advisor.

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