Understanding the chaos in commodity markets
TIT WORLD slot car racing championships are a microcosm of chaos. Tiny models of remote control cars ascend, descend and exit a complicated circuit faster than bewildered spectators can follow. It is impossible to predict the winners. This year’s race, which was scheduled to take place in America, has been canceled due to travel restrictions. But fans of high-risk betting might instead find solace in the equally baffling and rapidly changing world of commodities.
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Until recently, they seemed comfortably seated in the fast lane; the Dow Jones Commodity Index rose about 70% during the year through June. But the rally has since run out of steam. Some materials, like lithium, continue to climb. Other once hot products have backed down. The price of iron ore is down 45% since its peak in mid-July; wood, by 63% since the beginning of May.
Before, things were much simpler. During the 2000s, China’s rise to power fueled a commodity “supercycle”, a prolonged period of high prices. When Chinese growth slowed in the mid-2010s, the sustained boom ended. This time, however, no engine propels the raw materials up. Both supply and demand are hit by a series of short-term shocks that interact in unpredictable ways, creating a sense of chaos.
Three categories of shock matter. The first is the discontinuous and uneven nature of the economic recovery. China appeared in tears at the start of the year, but has since weakened. America is in full swing, with Europe in its wake, but the Delta variant and supply bottlenecks could slow it down. Many poor countries have yet to pick up the pace. All of this creates sudden surges in demand for raw materials at a time when producers and transport infrastructure, still disrupted by local episodes of covid-19, are already under pressure. The price of copper has increased with the recovery in demand, but also due to mine closures in South America at the start of the pandemic. Freight futures, which investors curiously classify as a commodity, have surged.
At the same time, governments are determined to accelerate the green transition. This creates demand for the wood and metals used to build wind and solar farms, and stimulates natural gas, a popular bridge between the dirtiest and the cleanest fuels. Lithium, used in electric vehicle batteries, rose 21% in September alone. The same underlying cause, climate change, is at the root of disruptive weather events. Snow in Brazil, for example, has helped push coffee prices up 22% since early July. In August, Hurricane Ida interrupted most of the offshore oil and gas production in the Gulf of Mexico.
Geopolitical tensions, the third driver, further cloud the outlook. Australia, a mining and agricultural giant, has forged a new alliance with America that aims to contain China, its main customer, after the Beijing government imposed embargoes on its precious exports. Russia is accused of limiting sales of natural gas to Europe to justify a controversial gas pipeline connecting it to the continent. The spot price of European gas has jumped by more than 80% since mid-August.
Combine these factors and you get a glimpse into commodity chaos. The iron ore has widened because China doesn’t want that much steel anymore. But coking coal, the other ingredient in the steel industry, is hot because Mongolia, a large producer, is in lockdown.
Oil crossed $ 80 a barrel for the first time in three years on September 28. The prices are high because OPEC and its allies are unusually disciplined in limiting production, and America’s shale wells, often quick to turn on the taps, are paying down debt instead. This would usually boost corn, the main component of American biofuel. But President Joe Biden is considering a reduction in the amount of biofuels that refiners have to put into the total fuel pool, which dampens demand. The price of palladium, used to make catalytic converters, has fallen 25% over the past month due to a microchip shortage that has halted auto production.
Jean-François Lambert, former head of commodity trade finance at HSBC, a bank, estimates that the chaos may well last until 2025, when market pressures begin to ease. Perhaps this is why few investors seem to want to bet on the direction of prices. Although commodities markets have attracted strong inflows since the start of the year, analysts at Capital Economics, a consultancy firm, believe this is mainly due to the popularity of exchange-traded funds that track gold. . Given the chaos in global commodity markets, it’s no surprise that investors want a safe haven.
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This article appeared in the Finance & economics section of the print edition under the title “Supermayhem”