The commodities bull run: not all that glitters is gold

THE commodities bull run has been the story of 2021. Across a wide range of product types, pricing of commodities has defied all expectations, some hitting levels unseen in the last decade.

With glittering forecasts sparking interest from new and experienced commodity investors, is there any reason for caution in the pursuit of the sector's golden upswing?

Euphoric declarations of a commodities super-cycle, last seen with China's massive industrialisation and urbanisation more than two decades ago, conveniently avoid a hard close look at the many disparate micro-climatic dynamics affecting each commodity type.

The perfect swirl of supply disruption and unexpected demand surge coupled with moving geopolitical factors have created a deluge, making it difficult to discern what is actual and what's apparent demand.

The bull run didn't start with the pandemic, but massive supply disruptions it caused, overlaid on existing tectonic changes in global trade, were enough to snowball acute shortages into a mindset of scarcity.

Faced with manpower shortages and regulatory restrictions, operations throughout the supply chain were thrown in disarray during the pandemic.

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Lawyers like myself spent the better part of 2020 advising on production, processing, and transportation disruptions as mines in South America, smelters in Asia and ports throughout the world struggled with keeping the flow of essential commodities.

In short, the pandemic exposed severe inefficiencies in a supply chain historically reliant on mechanical and manual input.

To add to that, production and processing of raw materials were tapered down in expectations of dwindling demand of industrial metals in a world focused on battling the pandemic.

Acute pandemic supply disruptions have to be overlaid with prevailing changes in trade flows.

The move away from fossil fuels has been in motion for several years with some of the largest and most efficient producers moving away from oil and coal assets, leaving a gap in the efficient delivery of some fossil fuels.

China's trade issues with both the United States and Australia, further affected dynamics as the world's largest consumer of a wide range of commodities sought to get its materials from elsewhere. Some commodities such as iron ore were experiencing existing shortages with closures affecting mines in Brazil.

These factors were already operating to change the movement of goods and today's dire shortage of shipping containers and resurrected freight rates are testament to the scale of such transformed trade flows.

Demand side

The demand side of the spectrum is just as multi-faceted: the initial shock of scarcity of materials has had profound impact on users and traders of commodities.

Faced with an uncertain supply horizon, some began increasing their inventories, to protect against future disruptions. This in turn drove pricing and may have fed some speculative behaviour which turned the wheels until actual and apparent demand were indistinguishable.

With loose monetary policies and liquidity converging on commodities perceived to be in shortage, the stage for the bull run was set.

And when economic recovery started taking shape quicker than expected, commodity prices became turbo-charged with a risk that demand may no longer track fundamentals.

The demand story for iron ore, coking coal and base metals is underpinned by an infrastructure push with both the Chinese and US economies using infrastructure programmes to drive a recovery.

An increasing momentum towards achieving green targets has shot up demand for metals such as copper, nickel and lithium, although the green movement is sometimes at odds with sky-high thermal coal prices used in much maligned carbon-producing power generation.

A focus on global emission standards has seen soaring demand for electric vehicles (EVs), solar panels and wind turbines which require up to five times more copper than its traditional counterparts.

As an example of this surging demand, in 2020 alone, the global stock of EVs hit 10 million, a multi-fold jump from just the year before.

But what is most often overlooked is consumer purchasing. Lockdowns across the world meant consumer products have skyrocketed, pulling demand for a variety of base metals used in electronic equipment.

The commodities boom of the early 2000s was driven by the demand boom of a growing Chinese middle class and today's global demand for consumer products seems to have not just replicated but amplified the conditions that lead to the previous China-led super-cycle in commodities.

But how much of this is sustainable?

As the world comes to terms with the pandemic, supply chain bottlenecks and inefficiencies are being addressed and more production capacity is returning.

Beijing even recently made an unusual announcement of the release of strategic stockpiles of industrial metals into the market. These developments are likely to change the perception of scarcity, which may turn the wheels back on demand.

Demand levels will also normalise as acute components of demand dissipate. Demand for consumer products is likely to fall as borders and opportunities open for spending in a post-pandemic world.

Apparent demand for commodities created by speculation and hoarding is also likely to decrease as these activities are now the subject of scrutiny from the Chinese government.

The fact that Beijing has recently given stern warnings to its companies against such practices hints at concerns at just how much apparent demand is contributing to souring prices.

Ultimately, prices for some commodities are likely to reflect this new rebalancing even if bullish forecasts predict only an upward trajectory.

For other commodity products, it appears that demand is yet to outstrip supply for some time to come.

Copper

Copper finds itself in such a situation.

The supply of copper is in shortage because new deposits are in geographically challenging areas and in any case have a production lead time of several years, not to mention significant capital expenditure.

Existing mining companies pressured by shareholders to maximise dividend returns in recent years face similar capital and time constraints to ramp up production.

The diverse demand for copper on the other hand is growing and is now not just China-centric.

Infrastructure programmes and green initiatives across the globe have sent copper demand soaring but these supply and demand drivers did not happen overnight so questions must be raised as to whether copper producers see the market differently.

After all, it was just a few years ago in 2015 that copper prices plunged from their own optimistic forecasts in the post-financial crisis world.

There are too many balls in the air to speak with certainty that elevated prices are the new norm for commodities.

A change in any number of factors - geopolitical, fiscal or economic - can significantly impact the dynamics of commodities with the events of the last two years providing valuable lessons.

In a red-hot commodities market, there is always a risk of prices derailing from market fundamentals and investors should be mindful that once the shock of actual scarcity and the perception of shortages are addressed, all that glitters may not be gold.

• The writer is the managing director of BlackStone & Gold LLC, a specialist commodities and international trade law firm based in Singapore. He can be reached at baldevbhinder@blackstonegold.com