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  • Writer's picturen ev

Energy prices and war are pushing up commodity prices.

The Bank of Canada’s commodity price index is at highs last seen in 2008 before the GFC. Continued supply disruptions, hoarding, and decent demand have taken us from the very lows of 2020 to these extreme highs. This could be the norm for a few more years yet whilst we wait for the supercycle to play out.

Commodities Analysis

Commodities overall have been doing well from 2020 to the present day during the reflation trade following the global lockdowns. Higher inflation has been ramped up by rising prices in the energy markets but also by continued strong demand and prolonged disruption in supply chains for a variety of reasons. We're in an established commodity supercycle and for anyone thinking it is about to end, we have potentially several years left before the next trough is due to complete.

Each commodity supercycle has a certain frequency and one of the most famous pieces of research into this was conducted by the Bank of Canada which has also come up with its own commodity price index.

If the consensus is that the 4th supercycle originated in 1996 and it lasts for 30 years, we have around 4 years before completion. This could come a year early (29 years) or possibly a few years late (33 years). Anyone buying commodities in the last year or so would have done well to have avoided the extreme highs seen in lumber, nickel, and energy to name just a few. But also, anyone holding inventory bought at the highs is now potentially seeing all their stock devalue as certain commodities come off their highs.

Supply shocks through the pandemic have taken a long time to ease and in some cases are still ongoing, especially with China still using a zero-tolerance policy to try and combat COVID. The Chinese authorities are locking down entire cities and many companies still struggle to maintain production during 2022. When one part of the chain is disrupted, the rest will follow, so China could be exporting supply chain disruptions for much longer. They may also cause a shift in aggregate global demand if they continue to stop economic activity, so the potential is for lower demand, lower prices, and possibly long-term stagflation or deflation.

The price of coal and the Dry Ships Index for me are related to economic demand and supply from China. Coal is off its recent highs but is still up 341.26% over the last 3 years. Wheat and corn are up 161.17% and 129.03% respectively. These are more affected by the situation in Ukraine.

Today US CPI figure shows a deceleration in the US inflation, as prices in energy have been going sideways within a $20 range since March. But it wasn't as low a print as analysts had been expecting, so inflation isn't going to dissipate as quickly as hoped. Though I am sure this will encourage speculation of a 75bps rate hike sometime in 2022, as one cure for higher prices, is higher prices. The Fed is set on reducing demand and maybe pricing people out is the only way.

China's commodities consumption to slow, no longer "big bulls", says analyst ©Reuters

Materials supply risks are rapidly disappearing without Chinese demand. Recent economic indicators indicate that China's appetite for raw materials has weakened since last year. The most-active iron ore futures on China’s Dalian Commodity Exchange, for September delivery, plunged as much as 7% to 756 yuan ($112.71) per tonne, the lowest since March 2016. In addition to price controls placed on commodities, new regulations are also helping to ease inflationary pressure on these commodities. Additionally, it is unclear how much deflation will be exported once the massive fleet of ships parked outside Shanghai's harbor walls is loaded and sent around the world on their deliveries. Chinese CPI rose today as people affected by the COVID restrictions, or worried that they would be in a lockdown, stocked up on food supplies.

Risk assets like US stocks have been liquidated by systematic trend followers as inflation rises. As a result, we have seen a dramatic decline in the major indices, which have accelerated lower today following the release of CPI data but could reverse in the US session judging from the price action since the US Open. Whenever prices hold below the 200-period moving average, all kinds of assets tend to sell off more, as trend followers pile in.

Gold has also been subjected to a large selling program in response to these similar trend signals. There is a possibility of a breakdown of support in the gold chart as gold prices challenge the psychologically important $1850/oz range.

The EU's efforts to achieve an oil ban on Russia may have stalled but energy supply risks are on the rise. Russia's oil exports could be significantly impacted by a potential ban on insurance or the lack of will to provide adequate insurance for a ship or its cargo in a war zone. This includes Ukraine as well as the Black Sea and especially after the Russian's most advanced and feared ship was sunk.

If the Fed does not engineer a hard landing or recession, the lack of oil exports from Russia could keep energy prices higher for longer, but that depends on demand remaining steady.

I would rather be a seller of Brent currently but whilst it is above the 200-period moving average this would be a countertrend trade and risky. Unlike shorting gold, which is below its 200-period moving average and moving away from a recent area of balance.


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