Three Reasons to Reload on Raw Material Investments
Commodity prices reached highs in early 2022 after Russian troops invaded Ukraine. Wheat, coal, gasoline, distillate fuels, gold, and copper reached all-time highs earlier this year, while many other raw materials, including crude oil and natural gas, rose to multi-year peaks. Since then, prices have retreated but remain elevated compared to past years. While geopolitical turmoil created explosive rallies, commodity prices had been heading higher since early 2020 lows as inflationary pressures eroded fiat currencies’ purchasing power. Artificially low-interest rates and unprecedented government stimulus programs created an environment where inflation thrived.
After blaming inflation on pandemic-inspired supply chain issues throughout much of 2021, the US central bank and government realized that the economic condition was far more than “transitory.” A shift to a hawkish approach to monetary policy has weighed on some commodity prices as the Fed accelerated interest rate hikes over the past months.
In June and July, the FOMC moved the short-term Fed Funds Rate 75 basis points higher each month to the 2.25% to 2.50% level as of August 2022. The market expects another 50 to 75 basis point hike at the September FOMC meeting. The central bank has committed to battling inflation via tighter monetary policy. At the annual Jackson Hole gathering on August 26, Fed Chairman Jerome Powell said higher interest rates “are the unfortunate costs of reducing inflation.”
Meanwhile, two consecutive quarterly declines in US GDP are the textbook definition of a recession. With the mid-term elections on the horizon, the US administration has refused to call the economic slowdown a recession, instead referring to it as a “transition.”
Markets reflect the economic and geopolitical landscapes. As we head into 2022’s final four months, many factors indicate an increase in market volatility. The recent price corrections in the commodities asset class could be temporary as supply-side inflation caused by geopolitical turmoil remains a clear and present economic danger.
Energy commodities remain at multi-year highs
- NYMEX crude oil pulled back from over the $130 per barrel level in March to $93 per barrel
- Coal and ethanol prices have pulled back from the 2022 highs.
- The volatile natural gas futures market flirted with the $10 per MMBtu level on the nearby futures contract during the week of August 22.
- As of August 25, the XLE, oil and gas ETF, was 49.3% higher in 2022, even though the S&P 500 has declined by 14.9%.
Agricultural products are at elevated price levels
- Nearby CBOT wheat futures traded to over $14 per bushel in 2022 and have pulled back to the $8 level.
- Nearby CBOT soybean futures reached the highest price since 2012 at over $17 per bushel this year and pulled back to $14.60.
- Nearby CBOT corn futures moved to over $8 per bushel in 2022 and were at over the $6.60 level on August 25.
- On August 25, shares in ADM and BG were 32.5% and 9.6% higher in 2022, respectively, despite the decline in the S&P 500 index.
Reason one- Geopolitics impact the supply-side of the fundamental equation
- The war in Ukraine is creating shortages in energy and agricultural markets.
- China is the world’s leading commodity producer and consumer.
- Deteriorating relations between China/Russia and the US/Europe interfere with commodity supply and demand fundamentals.
- Supply-side economic issues created by geopolitical tensions can have immunity to monetary policies.
Reason two- Inflation is a challenging beast- The Fed’s commitment faces conflicting pressures
- The July CPI, PPI, and PCE came in slightly lower than the June levels and the market’s expectations.
- The inflation barometers remain at the highest level in four decades.
- Q2 US GDP data was the second consecutive decline in economic growth, the textbook definition of a recession.
- The central banks are battling inflation and an economic slowdown, requiring different mutually exclusive approaches, and creating uncertainty in markets across all asset classes.
Reason three- Bull market trends since 2020 remain intact
- Commodities have been in a bullish trend since the 2020 lows.
- Commodity producers are profiting from prices at multi-year highs despite rising production costs.
- Energy and food commodities are weapons in an economic war between China/Russia and the US/Europe.
- Buying during corrections, establishing new long positions, or adding to existing risk positions, could be the optimal approach for the coming months.
- The XLE, PICK ETF, and companies like ADM and BG will likely continue to benefit from the economic and geopolitical landscapes.
Thanks for reading, and stay tuned for the next edition of the Tradier Rundown!