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Even as we grapple with the onset of wintry conditions, uncertainty about when lockdowns will end and new questions about the efficacy of vaccines, commodity markets continue to give all the appearance of great confidence in the future. Last week, some of the key building blocks of economic growth – like copper and nickel – traded at or close to multi-year highs, while oil finally recovered to pre-pandemic levels to over US$60 per barrel1.
This is less strange than it might first appear. While the demand for commodities worldwide has been depressed by the pandemic, so has supply. Miners as well as oil companies curbed spending on new projects last year, in response to low prices and falling demand. Since commodities are mostly priced in US dollars, the American currency’s recent decline has also acted to lift prices.
Today, each commodity has its own story, but supply constraints versus rising demand in Asia feature in many of them. Copper, for instance, is in a squeeze, with uncertainty over forthcoming spring elections and labour negotiations in Chile and Peru – the world’s largest copper producing nations – adding to existing concerns over pandemic-inspired mine closures. Demand, on the other hand, is only expected to increase, both from China and a growing electric vehicles industry.
Iron ore climbed a mountain last November and remains close to its 2020 peak2. Concerns about supply grew last month after Brazil’s Vale – one of the world’s largest producers of ore and pellets – lowered its production forecasts. China, meanwhile, is importing iron ore at record rates of around 100 million tonnes per month, as it pursues an infrastructure-led recovery requiring vast quantities of steel3.
So what’s new? Well, government stimulus programmes outside China – most notably in the US – could be set to further raise the demand for commodities. High on President Biden’s agenda are infrastructure building programmes and the speeding up of America’s transition to environmental sustainability. Roads, bridges, rail links, solar parks and wind farms will be heavy consumers of industrial commodities, along with some precious metals like silver.
The question is whether something like the commodities “supercycle” in the 2000s, which saw commodities ratchet higher over a period of years, is about to be repeated. Back then, the main driver was the Chinese economy. An extended period of rapid expansion – during which annual economic growth sometimes exceeded 10% per annum – caught the world short of basic commodities and it took a long time for the world’s major producers to catch up. The case for another supercycle hinges on history repeating on a similarly grand scale.
I have to admit to being somewhat wary of price trends apparently backed by so many factors all pointing in the same direction. That can mean a one-way journey could already be in the price, which almost invariably leads to disappointment. However, that’s not quite the case this time.
One missing link, for the time being, is inflation. Inflation has remained stubbornly grounded, with consumer prices in the countries of the G7 rising at an annual rate of just 1.2% in December4. That’s still well below both the 2% target rate set by most central banks and longer term trend rates.
The relationship between commodities and inflation is a complex one, but it’s generally accepted that they are correlated. When commodity prices rise, the input costs of manufacturers and services companies also rise, and that tends to push up the prices charged to consumers. Alternatively, higher commodity prices are reflected directly in the calculation of inflation measures, including consumer prices indices.
Government bonds in the US confirm the view from commodity desks that higher inflation is going to happen. The yields on longer dated Treasuries – those most at risk from rising inflation – have jumped since the start of this year5. When inflation expectations start to increase, bond yields also need to rise to compensate investors for the added risk to future fixed income returns.
Expectations that inflation will rise when it hasn’t yet have mixed implications for commodities. There’s a risk that investment flows into commodities may have pushed up prices too far, too soon. That may be especially so in an environment of near-zero interest rates and the declining attractiveness of another major asset class – in this instance, government bonds.
There’s also a risk the green energy revolution won’t happen as quickly as China’s rapid economic expansion in the 2000s. More importantly, it might not happen as fast as investors currently think. Take the electrification of transport, for instance. While Britain has pledged to ban the sale of cars with internal combustion engines (ICE) by 2030, Bloomberg New Energy Finance thinks ICE car sales globally won’t dip below 50% of total car sales until the late 2030s6.
Such considerations – along with the as-yet unseen tail effects of a sharp rise in unemployment globally – cast doubt on whether all the conditions are yet right for a commodities supercycle, although it could turn out that way, given a while longer. What we can say is that the market conditions for commodities have improved markedly over recent months, adding further weight to the view that the world economy will stage a synchronised recovery in the second half of this year and into 2022.
Fidelity’s Select 50 list of favourite funds provides plenty of scope to participate in strengthening economic conditions. The Fidelity Special Situations Fund, which focuses on UK businesses undergoing positive change yet to be recognised by the wider market, offers one such route. The construction company John Laing and fuels retailer DCC are among its largest investments currently.
Another Select 50 choice, the FP Foresight UK Infrastructure Income Fund, offers an exposure to investment companies dedicated to renewable energy and infrastructure projects and targets an attractive annual income from its investments of 5%, although this level of income is not guaranteed. It also has the potential to work as a partial hedge against inflation, in the context of a broader portfolio of investments in equities and bonds.
4OECD, accessed February 2021
5US Department of the Treasury, 11.02.21
6BNEF, May 2020
Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. Select 50 is not a personal recommendation to buy or sell a fund. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.