Wall Street analysts bet on another commodity rally before year-end

Traders, brokers and salespeople on the exchange vehemently open at the London Metal Exchange in London, UK, on ​​Monday, February 28, 2022.

Chris J. Ratcliffe | Bloomberg | beautiful pictures

Goods have widely pull back from their recent peaks, but Wall Street analysts say fundamentals are pointing to another rally later in the year.

As of Friday, the UBS CMCI (Commodity Expirations unchanged) is down about 11% from its peak in early June, while July’s performance was flat, but still up 16% year-to-date. present.

In a Friday research note, UBS Global Wealth Management strategists said the supply-side constraints that underpinned the rise in commodity prices in the first half of the year hampered the deteriorating outlook for global economic growth. U.S. dollar and China’s housing predicament.

While commodity prices could fall further in the event of a deep global economic downturn, UBS GWM Chief Investment Officer Mark Haefele and his team argue that a “soft landing” is now likely something like a marked slowdown.

They added that “excessively bearish orders in commodity markets do not fully account for supply-side dynamics.”

“Overall, commodity supply is constrained by years of non-investment – official inventories are low in many sectors – and due to factors related to weather and geopolitics. Meanwhile, we receive see a positive demand trend,” Haefele said.

For example, UBS expects Chinese demand to recover, with real estate and manufacturing data suggesting more fiscal stimulus is needed. While acknowledging that a “bazooka” policy is unlikely, Haefele hinted that more support from Beijing will come in the coming months, which should help stabilize demand for items like iron ore and industrial metals.

Bank strategists also see the US recession as premature and feel vindicated by the bumper nonfarm payrolls report. published earlier this month.

The US economy added 528,000 jobs in July, far exceeding consensus forecasts, while consumer price inflation slowed, suggesting the Federal Reserve may not have to tighten monetary policy aggressively. as previously expected.

“While growth is slowing, the US economy is also returning to its pre-pandemic pattern and
Haefele said.

“As manufacturing slows, services are growing. While diverging, the data reflects a normalization of goods and services activity.”

Third, UBS points to concerns about potential supply shortages, with industrial metals and steel at the heart of the new commodity cycle and the ingredients needed in the decarbonization process, making them important. the heart of the price recovery.

“While this story is not new, we believe the world is not yet prepared for the increase in demand associated with the transition; and despite higher prices, a decade of poor income and Environmental, social and governance (ESG) concerns have limited investment in Haefele given the future supply growth of important metals such as copper.

“That means production will struggle to keep up with increased demand. In the oil market, where there is a similar lack of investment, OPEC+ producers have limited or no capacity. reserved.”

UBS also sees supply disparities for agricultural commodities that will spill over into next year as the war in Ukraine continues, high energy prices, labor shortages and persistent climate-related problems.

Overall, commodities are “oversold,” Haefele said, and investors will begin to care less about short-term growth and more concerned about supply-side pressures from climate change, geolocation and climate change. politics and decarbonization efforts.

UBS maintains a 15-20% profit expectation on commodities over the next 6 to 12 months.

‘Irrational expectations’

UBS’s views mirror those of the Wall Street giants Goldman Sachswhich emphasized in a Thursday research note that “unreasonable expectations make prices unsustainable”, arguing that the current commodity pricing model has broken down.

“Today, the commodity market seems to hold irrational expectations due to falling prices and inventories
Together, demand surpassed expectations and disappointed supply,” said Jeff Currie, Goldman’s Head of Global Commodities Research.

“The only plausible explanation in our view is that inventory is caused by commodity consumers running out of inventory at higher prices, believing they can resupply once widespread discounts generate. excess supply,” added Currie.

However, if this proves to be incorrect and this excess supply does not materialize, he suggests that the scramble for inventory will lead to scarcity and push up prices significantly in the fall. This could force central banks to tighten monetary policy more aggressively and cause a longer economic contraction.

“Instead, markets appear to be pricing in a soft landing; further interest rate hikes, inflation reduction, and economic growth sufficient to keep earnings well supported in 2020. 2023,” Currie said.

“In our view, the macro markets are pricing in an unsustainable contradiction – it is difficult to balance a softening FCI [Financial Conditions Index]a more accommodative Fed pivot, lower inflation expectations, and a drag on inventories. “

Finally, the diagonal market curve shapes are flashing a warning signal for investors, Currie emphasized.

With the 2-year/10-year U.S. Treasury yield curve crossing and now inverting – an event the market considers a reliable indicator of an impending recession – commodity markets Turns out it should have come into “force,” said Currie, a situation in which the forward price exceeds the current price.

Commodity markets also tend to tighten most during the expansion phase of the business cycle, reversing course as rate expectations rise and the yield curve flattens out. When the yield curve is flat and recessions do not materialize, such as in 1995 and 2007, Currie notes that the oil market can “add more setbacks and steeper yield curves”, when the market tighten further in the future.

In contrast, when a fundamental downturn is in the works, commodity markets “are generally in a state of continuum and physical supply chains are destructive,” explains Currie.

“Today, the stock markets and commodity markets are signaling to investors more persistent demand and higher commodity inflation, while the rate and inflation curve are signaling a slowdown,” he said. decline and weakening of the economy is imminent,” he said.

“Until we see commodity fundamentals really soften, we’ll be accused of the former, not the latter.”

As a result, Goldman forecasts the S&P GSCI Commodity Index to rise 23.4 percent by year-end.

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