A hawkish turn by most major central banks (barring the Bank of Japan and the People’s Bank of China) is contributing to the expectation that higher rates and a strong US dollar will be a potential obstacle to further commodity appreciation in 2022.
Add to this the expectation of improved supply as the artificial constraints on supply chains imposed by the pandemic continue to be ironed out, and you have the possibility that some commodity markets’ prices may have risen too high. However, there are also some very compelling reasons for further commodity gains ahead for 2022.
Hawkish Central Banks And Inflation
Of course, a large piece of this puzzle is exactly how hawkish global central banks prove to be in 2022, and indeed how hawkish they can be before markets stumble or they start to curtail demand. The OECD leading indicators released for January are moving higher in over 65% of countries covered. This is a significant synchronized cyclical upswing across the global economy. The improvements might be related to the fading of some supply issues, and this will offer relief to some investors who are concerned about rising interest rates.
The first Friday of February came with some notable surprises, as nonfarm payrolls and average hourly earnings both surprised to the upside. Say what you will of the seasonal adjustments that led to nonfarm payrolls coming in at around 4x the average consensus estimate. Still, you have to think that, policy-wise, the Federal Reserve is feeling decidedly behind the curve at this point.
Perhaps a greater risk to commodity markets (and many others) could be the Fed getting this one wrong and hiking interest rates too quickly as the economy continues to show signs of slowing. Goldman Sachs recently cut its GDP growth expectations for the latter half of 2022, and many are now concerned that the combination of wage inflation and a shortage of both labor and raw materials are leading to an unavoidable economic slowdown. We’ve already witnessed the Fed being repeatedly on the wrong side of the inflation issue in a very public way throughout 2021, so it’s not too far-fetched to speculate that they could now come back and over-tighten just as they had previously over-eased. That is the lingering fear in the market, at least.
However, some commentators seem to think that the tightening cycle is being priced in and that raising rates a quarter of a percent will not markedly change consumer behavior because people still need to drive their cars and purchase food regardless of the broader interest rate regime. However, the knock-on effects of higher energy prices, a higher cost of credit, and the barriers to increasing supply due to ramping up decarbonization efforts are all authentic and should not be overlooked.
As far as precious metals are concerned, higher interest rates should, in principle, dampen the demand for gold which is a non-yielding asset and thus has an opportunity cost associated with holding it. The prospect of numerous rate hikes throughout 2022 has contributed to the bearish outlook on precious metals in general, and specifically, gold.
However, it’s worth considering that should inflationary pressures continue throughout 2022 (i.e., we don’t see the current shortages across the commodity complex transformed into surpluses), when combined with a slowing growth outlook, this could provide gold with a real opportunity to shine in 2022. It failed to attract much attention in an environment of combined rising inflation and growth in 2021, so gold could be about to come into its own this year if the data allows it.
The Tailwinds For Commodities
backwardation is the word on the lips of commodity investors at the moment. This is when the spot price is higher than the futures price. It indicates scarcity in the underlying commodity and that investors are scrambling to get their hands on whatever they can now rather than waiting to stock up at a later date.
At the close of 2021, all six of the main industrial metals, including copper, aluminum, zinc, lead, tin, and nickel, went into backwardation. There are now more individual commodities in backwardation than at any point since 1997, with a total of 19 out of 27 commodities now flashing this crucial scarcity signal.
In this month alone, we’ve seen diesel futures exhibiting their worst backwardation since 2008. Meanwhile, the cost per ton of aluminum has rocketed to its highest level since 2008. Furthermore, according to the London Metals Exchange, the last time nickel stockpiles registered an increase was in October of 2021, causing current investors to pay a $570 per ton premium on the industrial metal for immediate delivery rather than in three months.
Adverse growing conditions have also affected agricultural commodities, with coffee being one of the big stories of 2021, up almost 90% last year and currently breaking out to new multi-year highs. The same is true of cattle and oat futures, with wheat and corn having recently pulled back a touch and now looking like they may be attempting a new push higher. Remember that soft commodities are susceptible to more than just supply and demand. As already mentioned, increasingly unpredictable weather patterns are a crucial input that’s difficult to predict, as is the volatility surrounding oil, the other crucial input to agricultural production.
Speaking of oil, chronic underinvestment in oil exploration due to a combination of share buybacks, dividends, and debt repayment, as well as increased focus on green energy, has left many US producers incapable of increasing supply just as they require it most. This is while certain OPEC members seem unable to materially increase their production to meet OPEC output targets, as well as what may be viewed as the beginnings of a rift between OPEC’s number one and number three producers, Saudi Arabia and the UAE, respectively.
Finally, you may have noticed that COVID-19 still features heavily in analysts’ expectations, particularly when attempting to hedge their bets and account for a scenario where growth expectations are suddenly and unavoidably cut back. If Omicron does prove to be the death knell for COVID-19, then all of these pandemic-related hedges, including work from home weighing on services, will have to be taken off the table once and for all or, at the very least, until next time.