Why hedge your commodity risk?

Panic stimulus boom, commodity demand boom, price boom with supply disruptions on top. Bloomberg’s Commodity price index (CMCIPI) collapsed nearly 30% in the spring of 2020 to a level last seen in 2005, adjusted for the inflation, as the world was rattled by the pandemic.

Then came the panic stimulus boom. It led demand for commodities to explode: “We are running out of everything.” In addition, we got severe disruptions in the supply of natural gas, oil products and agri-products due to the Russia-Ukraine war. Commodity prices rallied nearly 140% to a new all-time-high in nominal terms and close to the peaks from 2008 and 2011 if adjusted for inflation. If we also adjust for the USD which was extremely weak in 2008 and 2011 and extremely strong in 2021-2022, then the CMCIPI commodity index peaked at 28% above all-time-high in April of 2022. Most important here was the demand impulse which was created by the stimulus even though the supply disruptions due to the Russia-Ukraine war, were severe and partially still are.

Inflation panic, sharpest rate hikes ever, cooldown and lower commodity prices

The Covid stimulus boom was unprecedented. It was nearly 10 times larger than the stimulus during the Global Financial Crisis (GFC) in percent of GDP. And the secondary effect of this was an eruption in inflation which we haven’t seen since the 1970s and early 1980s. Central bank panic again but now the other way. All breaks on. Synchronized rate hikes around the world at a speed we have never seen before with Quantitative Tightening (QT) on top. Demand has now started to ease and so has commodity prices. 

Gold could glimmer while oil and industrial metals could suffer in the short-term

Normal economic theory as well as historical experience calls for a recession down the road because of the very sharp and still ongoing rate hikes. Global manufacturing started to cool already in mid-2021 as stimulus started to fade. Global manufacturing is now contracting. US interest rates however didn’t start to rise before March 2022 and has risen at record speed since then. The negative economic effect of this is mostly still ahead of us. This has the potential to drive the US economy into recession and hurt demand and prices for both oil and industrial metals. A recession, if it unfolds, would be accompanied by further decline in inflation and deep rate cuts by the US Fed. This is normally bullish for gold prices. Holding some portions of gold could thus turn out to be a good strategy for the coming year even tough a recession is not SEB’s base case.

Capex spending cuts again and again and again is setting us up for high prices next 10 years

The China construction boom started to fade in 2012. There were however many new commodities supply projects under construction at that time. These were finalized and commissioned the following 5-10 years while few new projects were initiated. Capex spending was cut yet deeper during the pandemic years of 2020-2022. And now, if we get a post-pandemic recession, capex spending in new commodity supply will be cut yet again. The pipeline of new commodity supply coming online the next 5-10 years is thus limited. There is only one way to drive capex spending higher and that is higher prices. So, before we can get higher supply, we’ll first have to have higher prices. But that may not happen before we have moved through a potential post-pandemic recession.

Hedge your bets in a potentially increasingly volatile commodity price world

The increasingly digitized world is leading to increasing synchronization of global financial flows as everyone gets to know everything, even the smallest details, at almost the same time. Extreme market moves should thus become even more frequent. Splitting the commodity world into friendly and non-friendly as well as green and non-green suppliers is in addition leading to more fragile, illiquid, and opaque commodity markets. Hedging commodity price exposures will likely become even more important going forward. The commodity roller coaster years of 2020-2023 is a good example of how extreme the moves can be. It won’t be the last time we see this.