Many commodities have boomed, driven by a confluence of forces:
- ongoing monetary and fiscal stimulus;
- accelerating post-pandemic global economic growth;
- long-term underinvestment in commodity production capacity;
- pandemic-related supply chain and shipping disruptions;
- the rise of sustainability metrics for public companies;
- the push for decarbonization and the electrification of the global economy;
- a bolus of consumer spending enabled by stimulus checks;
- and the unpredictable effects of China’s ambitions.
The Federal Reserve and some analysts believe that inflation will be transitory; but rising commodity prices are already finding their way into the prices that consumers pay for many essential goods. Having raised prices and improved margins, companies will be loath to roll them back. Inflation may be peaking as we lap the year-on-year declines from the beginning of the pandemic, but we think even the official numbers will be higher — and will last longer — than most analysts expect.
Of course there are many disinflationary forces still at work in the world, many of them technological. But if the pandemic did coincide with a bottom in inflation and bond yields, investors will be facing an environment different from anything they have seen for more than 30 years. A generation of investors and money managers who have never lived through a period of inflation and rising rates may find their old certainties and established strategies challenged. Commodities can be a critical tool for protecting and growing portfolios in the environment that is developing.
Lumber, grains, oilseeds, industrial metals (especially copper), rare earths, and uranium are all of interest to us. Precious metals — some of which also have significant industrial and technological applications — have recently seen modest improvement.
Why the Commodity Boom Can Last
Above we gave a summary list of the forces that have made commodities the outperforming asset class thus far in 2021 (aside from cryptocurrencies). Here we’ll comment on a few of them a little further.
Supply constraints. For the past decade of sluggish growth and challenged commodity performance, producers have underinvested in new capacity. Many even now, especially Latin American base metals producers, are showing discipline in planning expansion. Global scale industrial metals production and capacity expansion is an enormously complex capital allocation problem; new capacity takes years to develop even if demand is rising. That dislocation can be resolved only by rising prices.
Shipping disruptions. The on/off/on of the pandemic has created unprecedented pressure on global shipping prices, particularly for commodities which are shipped in containers rather than in bulk. Anecdotal reports show exporters buying spot shipping capacity unable to get their goods loaded at any price, or exploring lengthier, more circuitous routes just to get their goods to market. Those shipping costs are flowing through to commodity prices. The pandemic laid bare some of the consequences of the highly “efficient” just-in-time delivery system built up over the past few decades — showing that such “efficiency” can become a source of fragility and volatility.
Sustainability metrics… and virtue signaling. Lumber is one commodity that has seen rapid price rises, as the pandemic has created unprecedented demand for single-family housing — and perhaps at last sparked the fire of Millennial “nesting” which we have long anticipated. However, at the same time that lumber is needed for construction, large corporations who want to put a “carbon neutral” stamp on their investor presentations and marketing programs are locking up vast swaths of timber across the U.S. They pay timber owners to leave their trees standing. We love forests, but the irony is not lost on us that companies who are massaging their ESG ratings to look better to investors are contributing significantly to the inability of would-be new homeowners to afford a house. While seeming to be virtuous, these would-be do-gooders may in fact be reinforcing the very inequality that they decry in public. (You know what they say about the paving stones of a certain road.) In any event, the push for carbon neutrality is adding fuel to the fire of an already hot lumber market. This does not look like a transient trend — it looks more like a cultural shift.
Another such shift is doing similar things to corn. 40% of U.S. corn production goes to ethanol production for mandated inclusion in motor vehicle fuel — a situation which we view as one of the most senseless and costly boondoggles in regulatory history. (All of the energy inputs to corn ethanol production come close to equaling the energy output of the ethanol produced — making the whole system a wash in terms of sustainability.) The Biden administration is moving back towards enforcing ethanol fuel mandates more strictly; at the same time, the USDA reports that acreage planned to be planted this year is significantly below average. This is a recipe for the corn price spike to continue.
And copper is gaining new significance, with other technological and industrial minerals also participating. The shift to a decarbonized, electrified, networked global economy is an enduring theme and highly unlikely to be reversed short of some science fiction global catastrophe that sends us back to the Middle Ages. (In other words, it’s not happening.)
Copper is the common denominator of most parts of this process. The pandemic has caused an inflection in this theme, at the same time, as noted above, that long-term supply faces significant constraints. Accelerating growth; accelerating intensity of demand for technological metals; and constrained supply all argue to us that the copper bull market could still be in early innings, and may run for years if new technologies continue to use copper in the same way as in the past. The same could be said for other base metals, and particularly, for rare earths.
Of course, many commodity prices won’t go up forever. At some point, the phenomenon of substitution will kick in, which will see innovative technology replacing more costly industrial materials with new techniques for employing less costly ones in their place. As the saying goes, “The cure for high prices is high prices.”
We note also that many of the forces we have discussed have added significantly to market volatility and unpredictability, with price movements showing faster and deeper swings as traders struggle to incorporate the host of relevant objective and subjective data. Old models may not be useful.
Investment implications: Commodities consolidated during March and early April, when new lockdowns in Europe briefly threatened the re-opening consensus. Recently, they’ve taken off again. In the post-pandemic environment that is emerging — with inflation that we believe is unlikely to be “transient,” a major inflection of green themes, and likely enduring under-capacity in many areas — we think commodities may become a valuable component of portfolios to boost diversification and risk-adjusted returns for at least the next several months.
