Commodities could pull back more this year as supply outpaces demand growth

AFTER a stellar year in 2022, commodities could likely book a weaker performance this year on the back of factors such as the strengthening US dollar, greater stability in supply and weakening demand.

Commodities were the best performing asset class in 2022, rewarding investors with solid returns across the board. This was driven by renewed demand amid the gradual easing of Covid-19 restrictions across different countries. 

But on a year-to-date basis, several commodities have booked declines. Sabrin Chowdhury, head of commodities analysis at Fitch Solutions unit BMI, said commodities “now bag the title of the worst performer in 2023 thus far”. 

She said several factors have contributed to the disappointing performance of commodities – including the strengthening of the US dollar in May. Commodity prices have historically had a negative correlation with the greenback.

There has also been weak global demand for physical commodities, and a “stark divergence” between commodity-heavy manufacturing activity and the services sector globally. Supply has also been more stable this year than last, in terms of both production and exports.

Expectations that mainland China’s economic recovery would accelerate demand for commodities were left unmet, Chowdhury added.

“Mainland China’s physical demand for most heavy commodities remains tepid at best, and has led to a large build-up of stocks,” she said. 

Most precious metals have fallen in price, except for gold. Silver and copper are down 4.7 per cent and 3.9 per cent, respectively, this year. Gold, meanwhile, is up 7.2 per cent as investors have piled into the precious yellow metal amid macroeconomic uncertainties such as the banking crisis and US debt ceiling deal.

Robin Tsui, Asia-Pacific gold strategist at State Street Global Advisors, said gold often gets bundled up with other precious metals, but its “unique fundamentals and characteristics” should warrant its own classification as an independent asset class. 

Tsui said demand for silver and platinum are heavily driven by the jewellery, automotive and industrial sectors, all of which are cyclical drivers. Gold demand, on the other hand, is driven by jewellery, industrial requirements, investment demand and central bank buying. The yellow metal’s diverse sources of demand – both cyclical and counter-cyclical – have been the source of gold’s “low historical correlation to financial assets”, he said. 

So far this year, Tsui noted that gold has outperformed other traditional safe-haven assets such as the US dollar, Japanese yen, US treasuries and global bonds. He said gold has tested its record high of US$2,075 per ounce several times this year. 

“Global investors and central banks have turned to gold in diversifying their investment risks from the global banking crisis, the rising risk of a US recession as well as geopolitical tensions and potential market shocks that may threaten financial stability,” he said. 

Tsui expects gold prices to remain supportive this year in light of such developments and the likelihood of the US Federal Reserve pausing rate hikes in the second half of the year. The yellow metal may also break the all-time high in H2 this year, he added.

Nickel, which has been touted by market watchers as the metal to watch amid rising demand for electric vehicles (EVs), is down 31 per cent year to date.

Demand for EVs remained “largely tepid” in the first quarter, said S&P analysts in an April note. “Market participants expect tepid demand to last through the next quarter, with little signs of recovery seen from the electric vehicle sector,” they added. 

It was recently reported that China’s imports of refined nickel have fallen to levels that were last seen nearly two decades ago. 

There has also been a nickel supply glut. S&P forecast that Indonesian primary nickel supply growth will cause the global primary nickel market to be in a surplus of 174,000 tonnes this year, from 113,000 tonnes in 2022.

Among the agricultural commodities, palm oil prices have eased this year after hitting record highs in 2022. Fitch Ratings said foreign worker availability in Malaysia is gradually improving, and supply could be boosted by healthy soil moisture conditions and lower flooding-related disruptions.

Corn and wheat, which suffered a spike in prices on the back of the Russia-Ukraine war, are down this year as their demand-supply dynamics have evened out. Rice and soybeans are also down year to date.

Several agri commodities could see shocks to their supply, however, and are up this year. 

Arabica and robusta variants of coffee, for instance, are up year to date. BMI analysts said in a recent note that there are concerns over tight supply, stemming from the harvest situation in Brazil and Colombia.

The International Coffee Organization is expecting a production deficit for the second successive year, although upward price momentum is now being capped by worries over demand, amid the backdrop of a slowing global economy.

Sugar prices are being supported by repeated downgrades to the Indian sugarcane harvest and the drawing forward of El Nino expectations. The weather phenomenon typically brings reduced rainfall to Asia’s major producers and heavy rains to Brazil, which threatens their respective domestic harvests.

Similarly, concerns about tight supply in West Africa continue to support global cocoa prices.

BMI’s Chowdhury said commodity prices will see a “minimal” recovery in H2, stemming mainly from a pickup in the manufacturing and construction sectors in China. 

She said precious metals have the most positive outlook, with gold prices likely to break through their all-time highs later in the year when the US Fed reaches terminal rates or starts to cut.

“At the other end of the spectrum, the weakest outlook is for energy, with natural gas prices already having reached pre-Covid lows and coal on its way there,” she added.