A Rising Tide Floats All Commodities?
When people think about the macro they often loop all commodities together. It can be the case where commodities move in the same general direction due to the number of CTAs & macro hedge funds that have commodity exposure flowing in the same direction. For example, when there is a general risk-on sentiment we tend to see heavy inflows into most commodities and hence rising prices - prime example of this was entering 2022 where the world believed Covid was behind us and most commodity markets saw inflows of funds. A lot of these hedge funds will use similar weightings for their portfolios to the Bloomberg Commodity Index (BCOM) so as more money flows into those funds, more buying is seen on all of the commodities contained in the BCOM. However, in times of less certainty, the picture becomes a lot less clear and we need to consider various macro influences when looking at the basket of commodities and particularly base metals. Currently there is a potentially huge deterrent to higher metal prices which is the impact oil price moves are having on the global discourse, both at central government levels and the end consumer's thought process.
The US FED has spend the last 2 years battling inflation, and after taming it from 10% down to current levels around 2.5%, they have entered a rate cutting cycle. The metal market has so far taken this as a bullish sign across the board - as money becomes cheaper to borrow, demand for raw materials should increase as consumers have more access to spending. As discussed in a previous article, a decreasing US FED interest rate historically leads to a weaker US Dollar that makes commodities priced in USD cheaper by comparison. The metals markets have also recently been buoyed by a huge stimulus announced by China that has been described as a 'whatever-it-takes' stimulus package. Property developer stocks in China are already significantly higher since the stimulus was announced, and considering ~25% of China's GDP comes from the property sector, you can see how this might be pointing to a dramatic increase in base metals.
However, one thing that could stand in the way of this is if oil prices start moving drastically up. With the extension of the violence in the Middle East into surrounding countries, we have seen the oil price increase 17% over the last month (as of the time of writing). There are no signs that a ceasefire is on the horizon and this uncertainty is causing a dramatic shift in dynamic. If Israel actually starts targeting Iranian oil fields or the conflict grows wider still, we could easily see the oil price increase further.
Separately to the conflict, there are those that are confident Saudi will release more oil in order to not lose market share to other OPEC+ countries that may have been skirting agreed production cuts. However, there has been no concrete evidence Saudi will flood the market with oil so the these talks may have been premature, and they could instead just take a harder line with those countries and force them to cut back production as they agreed to. Alongside that, the heads of the biggest trading companies (such as Ben Luckock, global head of oil at Trafigura) are arguing that "Once oil is in the $60s [per barrel], it's a dangerous place to be short" - definitely a look into their views but perhaps a look into their positioning as well!
As we move toward the green energy transition there will come a time when economies are far less dependent on oil than they are today but for now, oil is still very much the backbone of global economies and so a rising oil price can have a huge knock-on effect on other prices. As it stands, oil (in some form) is used in practically every global market. Whether that is for fuel in machinery, or oil products that are used in various parts of the global supply chain, the impacts of oil on global markets can't be understated. A higher oil price can lead to an increase in the price of everything from gas at the pump and food in grocery stores and restaurants, to end consumer products given the exposure all of these industries have to the price of oil in their production. This has the potential to decrease demand in all of those industries. A decreased level of global demand may well keep a cap on metal prices for now, regardless of central government policy. The key question is if oil does move drastically higher, will the demand destruction that stems from a potentially higher inflation rate, outweigh the positive impacts on demand of other global macro factors.
The US FED (not even taking into account the recent higher than expected jobs numbers) will be paying extremely close attention to oil prices and the potential for the return of higher inflation. Higher oil prices could provide a catalyst to pause rate decreases which the market would not look kindly to given how many rate cuts have now been priced in over the next 12 months.
