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.