Commodity markets are all gummed up
Summary
- Commodities are a favorite play at times of high inflation, but there are unusual risk factors right now
Commodities are a favorite play during periods of high inflation, but the market—particularly for metals like copper and steel—is undergoing some unusual contortions. Buyers should be aware that they are betting on Chinese climate policy and global trade bottlenecks as much as supply and demand.
Even given that commodities are notoriously volatile and speculative, the recent sharp divergence among industrial metals—whose prices typically move more or less together—has been striking. Steel is up sharply. The iron ore used to make it is down. Copper, after marching higher throughout late 2020, has been muddling through since May. Aluminum, meanwhile, keeps setting 10-year highs.
What are investors to make of all this?
Iron ore and steel are easiest to explain but also the most vulnerable to a quick reversal. In early 2021 Chinese property investment, the most important source of global steel demand, was rising at its fastest rate since the early 2010s, while Chinese steelmakers were running factories at full tilt. The combination lifted prices for both steel and iron ore.
The steelmakers were pushing in expectation of tough curbs on output in late 2021: Chinese regulators have repeatedly pledged to limit production this year to 2020 levels, as part of the national plan to cap carbon emissions. Now those restrictions are biting as expected. Many steelmakers can’t produce at all, which has hit iron-ore prices hard, while those still cranking out steel can charge a premium for it. Since June, U.S. hot-rolled coil steel futures are up 6%; iron ore, down more than 30%.
What’s next? Steel prices might begin to roll over late this year as China’s property sector slows more sharply, then crash in early 2022 as local governments allow mills to restart. Or Beijing might hold the line on steel output into 2022, easing the steel-price decline but hitting iron ore even harder.
Beijing’s emissions efforts are also supporting the price of aluminum—like steel, a metal whose production is one of the world’s most energy-intensive processes. Shipping bottlenecks are another factor. Last year China became a net importer of aluminum for the first time since 2009, an incentive for traders to move warehouse stocks to Asia. Now, as China’s economy slows, aluminum is marooned in Asian warehouses and struggling to head west—where the demand is—because of those bottlenecks.
One reason copper might be performing worse than aluminum is that the demand-chasing westward shift in inventories is further along. Since May, inventories at the Shanghai Futures Exchange have fallen by more than half, according to Wind, and inventories at the London Metal Exchange have roughly doubled. Sunday’s coup in Guinea, the largest exporter of bauxite—necessary to make aluminum—could exacerbate copper’s relative underperformance.
The one thing that does seem clear in this morass is that previously reliable leading indicators of metal prices, such as Chinese credit growth, have grown less so. Heavy-handed policy makers and shipping constraints are gumming up the market. The best strategy for most investors could be to wait until that extra grit has worked its way through.
This story has been published from a wire agency feed without modifications to the text
