North America April 13, 2021 / 12:20 pm UTC

Commodities Price Divergence

By Mike Gallagher

Bottom line: The commodity price surge is becoming more selective and we remain most bullish on commodities such as copper and corn, where cyclical recovery is being complemented by healthy structural demand and headwinds to new supply growth. In contrast, weak demand for gold in the non-financial sector leaves gold prices vulnerable to further price declines, as 10yr U.S. yields rise further. 

Figure 1: Commodity Price Divergence 

Source: Continuum Economics, Datastream

Divergent Demand/Supply Fundamentals 

The fortunes of various commodities are diverging, as the reality of contrasting demand/supply outlooks impacts the previous across the board bullishness. Corn continues to power higher, as inventory levels outside of China remain low and China’s purchases continue at an elevated pace, which we highlighted in a recent article. China has a structural problem of the growth in food demand outstripping domestic supply, both due to rising incomes boosting demand and because grain production growth is limited by the lack of spare land, water availability and over-fertilization of land. The current cyclical boost to China foreign grain purchases may ebb, but the structural problem will remain. In contrast, gold speculative bulls in financial markets have had to face up to the hard reality that non-financial demand for gold has decreased as central banks have slowed gold purchases. This has left gold vulnerable to a recovery in nominal and real U.S. government bond yields, where gold is inversely correlated. We forecast gold prices falling to $1,675 and $1,625 by end-2021 and end-2022, given that we forecast 10yr U.S. yields rising to 2.5%

Speculative financial interest can sustain a commodity price trend for months, as occurred after the vaccine breakthrough news in November. However, multi-quarter and multi-year, commodity prices are dependent on the physical demand and supply picture. 

Figure 2: Net Speculative Positions CFTC 

Source: CFTC, Continuum Economics

On copper, we remain bullish for $10,000 by end-2022, as cyclical demand has been helped by the unsynchronized, but ongoing, recovery in the world economy and the structural demand from the electric vehicle revolution kicking in more substantively. China’s shift of emphasis from growth to sustainable growth will eventually slow cyclical copper demand, but other EM can still provide cyclical and structural demand. On the supply side, new mine projects will boost supply, but mine and ore dilapidations are a large counterbalance and means that production will grow more slowly than demand. Inventory rundowns are not a long-term solution, as they are not excessive. This means that higher copper prices are required to incentivize new mining projects, which take years to come on stream due to project complexity. Copper prices will likely hit $10,000, but could surge to $12,000 in the coming years. It is right to talk about a mini supercycle in copper. 2021 price action could be choppy however, as a sharp build-up in financial positions (Figure 2) could act as a headwind to the structural bull trend.

Oil in contrast has cyclical and structural demand/supply positions that differ. Oil demand is recovering with the global economy and the cyclical acceleration will only slow into 2023. Cyclical supply is restrained by OPEC+ retaining production cuts, which have been removed more slowly than anticipated. However, OPEC+ and Saudi Arabia’s voluntary production cuts are now starting to be reversed in Q2, after the decision at the April OPEC+ meeting, and this has taken the edge off oil price bullishness. Structurally the growth in demand for oil will continue to slow, both as DM economies decrease oil usage in line with climate change plans and as EM economies change the mix of power generation toward gas/renewables and away from oil. Transport will be slower to diversify from oil, and oil demand will be boosted by structural EM growth. Structurally the growth in the supply of oil is constrained, due both to the periods of low oil prices in recent years and to the long-term structural headwinds of climate change impacting the source of energy use. On a cyclical basis, we forecast WTI at $62 and $68 by end-2021 and end-2022, and it could go higher if OPEC+ pause the production build-up. The price picture then becomes choppier, as demand growth slows from the quick cyclical recovery pace but new supply growth remains modest. Although the next 18 months remains bullish for oil prices, it is difficult to call it a mini supercycle for oil.

4Cast Ltd. and all of its affiliates (Continuum Economics) do not conduct “investment research” as defined in the FCA Conduct of Business Sourcebook (COBS) section 12 nor do they provide “advice about securities” as defined in the Regulation of Investment Advisors by the U.S. SEC. Continuum Economics is not regulated by the SEC or by the FCA or by any other regulatory body. This research report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. Nonetheless, Continuum Economics has an internal policy that prohibits “front-running” and that is designed to minimize the risk of receiving or misusing confidential or potentially material non-public information. The views and conclusions expressed here may be changed without notice. Continuum Economics, its partners and employees make no representation about the completeness or accuracy of the data, calculations, information or opinions contained in this report. This report may not be copied, redistributed or reproduced in part or whole without Continuum Economics’s express permission. Information contained in this report or relied upon in its construction may previously have been disclosed under a consulting agreement with one or more clients. The prices of securities referred to in the report may rise or fall and past performance and forecasts should not be treated as a reliable indicator of future performance or results. This report is not directed to you if Continuum Economics is barred from doing so in your jurisdiction. Nor is it an offer or solicitation to buy or sell securities or to enter into any investment transaction or use any investment service.
Analyst Certification
I, Mike Gallagher, the lead analyst certify that the views expressed herein are mine and are clear, fair and not misleading at the time of publication. They have not been influenced by any relationship, either a personal relationship of mine or a relationship of the firm, to any entity described or referred to herein nor to any client of Continuum Economics nor has any inducement been received in relation to those views. I further certify that in the preparation and publication of this report I have at all times followed all relevant Continuum Economics compliance protocols including those reasonably seeking to prevent the receipt or misuse of material non-public information.