By Stan Bharti, founder and executive chairman of Forbes & Manhattan
Investors are always searching for ideal market conditions to book profits and diversify their portfolios. In 2021, the commodities market was a lucrative destination for investors as prices reached record highs. Commodities continued to outperform in 2022 as the Global Commodities Index surged 36% in 6 months.
However, in July 2022, energy prices fell by 1.3%, non-energy by 8.9%, agriculture by 7.4%, metals by 13.4%, and raw materials by 6.2%. Consequently, investors are now getting wary of the commodities market and reallocating their funds to maintain a profitable portfolio. But, is it a wise decision to stop investing in commodities? To answer the question, one has to understand the broader market scenario.
Inflation Management Is Affecting Commodity Prices
In 2022, the International Monetary Fund (IMF) projected inflation rates of 5.7% for advanced economies and 8.7% for developing economies. Globally, governments respond to bring down high inflation by taking proactive steps. Administratively, it means rising interest rates to make everything costlier and thereby reducing people’s purchasing power.
Paul Volcker, the Chairman of the Federal Reserve Board, was the first person to try the strategy to control inflation in 80s America. He raised the interest rates to almost 20%, thereby manufacturing two short recessions. Due to the Volcker Shock, the Consumer Price Index (CPI) fell from 14.85% to 2.5% in a year, and commodity prices crashed.
Since the 80s, governments have been using the Volcker strategy to control inflation. Therefore, even in 2022, the U.S. Federal Reserve has consistently hiked interest rates, taking the benchmark overnight borrowing to 2.25-2.5%. The results have been successful as monthly import prices dropped by 1.4% for the first time in 2022, and producer prices fell by 0.5%.
Although overall price decline indicates inflationary pressures are finally easing out, the Federal Reserve might continue with interest rate hikes. This indicates a short-term deflationary pullback rather than definitively coming out of inflation.
Inflation is Here to Stay
Governmental efforts have slowed down headline inflation due to demand destruction from rising interest rates. But there are other factors at play that can potentially lead to a fresh spike in commodity prices.
For example, petroleum prices are now falling because the government is selling strategic petroleum reserves, thereby reducing pressure on energy prices. However, no new capacity has been added to the energy market recently. Thus, when the government stops selling from the strategic petroleum reserves, energy prices will start rising again. This would once again lead to a spike in inflation rates.
Additionally, there is a growing difference between headline inflation and core inflation. The temporary suppression of energy prices has ensured headline inflation remains stable. But core inflation has increased due to a steady rise in rents and other non-food/energy prices. This indicates that inflation will continue to rise followed by a steady gain in commodity prices.
The European energy market also demonstrates that inflation is now a long-drawn affair. The major oil-producing companies are almost full to their capacity with no extra storage facilities. Moreover, there are no incentives to invest in capacity building and scaling operations in the long term. Therefore, it is difficult to quash inflation in the near future and commodity prices will continue to remain high.
There Are Other Pieces In The Commodities Puzzle
Certain macro factors are causing a temporary dip in commodity prices. But this is an inevitable occurrence in a commodity cycle and indicates a minor plunge in an otherwise commodity boom period.
Take the example of agricultural crops. High grain prices are ideal incentives for farmers to maximize their production capacities with adequate irrigation facilities and pest control techniques. However, bumper harvests lead to oversupply, and prices crash as demand remains the same.
Metal prices also share the same fate. For instance, investors remained bullish on copper since it is a primary component in electric vehicle batteries and appliances. Copper prices were rising steadily, reaching a high of $4.72 per pound in April 2022. But the boom also led to the opening of new mines and refinery capacities. The International Copper Study Group suggests a 328,000-tonne surplus in 2022, and copper prices have now started declining.
The commodities market is highly volatile and immediate price fluctuations are often tied to daily news reactions. Like on 12th August 2022, oil prices dropped by 2% amidst news of damaged pipeline replacement easing supply disruptions in the U.S. Gulf of Mexico.
However, the price dip is temporary and a natural occurrence in a commodity cycle. Demand for copper will once again rise due to a steady push towards electricity-driven transport and new electric grids. Similarly, the demand for oil will also rise as there is no new capacity to compensate for the rising demand.
The Commodities Market is A Phoenix
Remember the Phoenix, a mythical, immortal bird, that cyclically regenerates itself from its ashes? The commodity market is similar to the Phoenix, cyclically rising from the deathbed. So, even if commodity prices plunge now, they are sure to emerge stronger in the future. History has demonstrated that revival is inevitable after a slump in commodity prices. Just like the Sun rises in the east, a fall in commodity prices will be followed by a commodity boom. It is indeed a truism.
Therefore, despite the current commodities slump, JPMorgan Chase & Co. strategists have advised reallocating funds from equities and stocks to commodities. The weakening prices offer a window of opportunity to buy the dip, only to profit later. Although equities will continue to rise through 2022, the commodity market will emerge stronger than its current levels.
To this end, leading private merchant banks like Toronto-based Forbes & Manhattan (F&M) will guide investors towards the right commodity baskets. The F&M team will ensure investors have a future-proof portfolio for the commodity boom that is coming.
About the Author:
Stan Bharti is a recognized international businessman and entrepreneur with over thirty years of hands-on experience in the mining, oil and gas, technology and finance sectors. Stan is the Founder and Executive Chairman of Forbes & Manhattan Inc, an international merchant bank and finance house focused on natural resources, infrastructure, energy and technology. Forbes is recognized around the world as a leader in discovering, financing and building projects through to completion.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.