World Bank Commodity Survey (May 2022)…

·        Overview

Global commodity markets are being permanently reshaped as a result of the effects of COVID-19, the war in Ukraine and climate change. According to a World Bank study, there is likely to be a transformation that will have profound implications for emerging economies in the coming decades.

As population growth slows and emerging economies mature, growth in overall global commodity demand is likely to slow, although demand for some commodities is likely to increase.

Increasing demand for metals needed to build renewable energy infrastructure and manufacture electric vehicles is likely to increase the prices of metals in the coming years and bring unexpected gains to their exporting countries.

“Amid the overlapping crises over the past two years and the continued transition to lower carbon intensity, commodity markets are reshaping,” said World Bank Group President David Malpass. “These changes will have significant implications for growth and poverty reduction in emerging economies, two-thirds of whom are commodity exporters. A solid goal is that changes in commodities markets promote good outcomes for both development and environmental sustainability.”

The analysis reveals that commodity price shocks affect different commodity exporters differently and why policy solutions must be tailored to reflect each country’s particular circumstances.

·        What can policy makers do?

o   Financial, monetary and regulatory frameworks:

Governments should create a fiscal framework that uses periods of high prices to generate bad day funds that can be deployed quickly in an emergency. Exchange rate regimes need to be agile to work effectively with well-defined monetary policy frameworks. Regulators should take measures to prevent the accumulation of excessive financial sector risks, particularly in relation to capital inflows and foreign currency debt.

o   Measures to mitigate rise-fall cycles:

Governments tend to resort to subsidies or trade protections to mitigate the effects of commodity price movements on consumers. Commodity exporting countries often try to reduce market volatility by reaching agreements to regulate supplies. History shows that such efforts are often costly and inefficient. A better approach is to adopt market-based risk mechanisms to limit exposure to price movements.

o   Economic diversification:

Faced with a long-term decline in fossil fuel demand, countries exporting such fuels must continue to diversify their economies. Low-income countries heavily dependent on agricultural exports will also benefit from reforms that help expand other sectors of their economy. These efforts can be supported by building human capital, promoting competition, strengthening institutions and reducing distorting subsidies.

·        Commodity Market in May during the study

Fearing faster inflation, increased geopolitical risks, and accumulated portfolio losses, investors are turning to commodity exchange-traded funds to protect their portfolios. According to Morningstar, $21.4 billion flowed into commodity ETFs by April this year, versus $63 billion in outflows in the first four months of 2021. Commodity bulls may soon regret their enthusiasm, as both demand and supply forces are likely to start driving prices down soon.

Commodities managed to rise even as stocks and bonds fell… Source: Bloomberg

The impact of Covid-19 on demand… Covid-19 has led to ongoing lockdowns in China, causing dramatic production cuts in the world’s second largest economy, which accounts for 18.1% of global gross domestic product and 23.9% of production. The pain spread to China’s imports of oil, copper and iron ore from countries such as Brazil, Chile and Australia, as well as manufacturing exporters such as Germany, South Korea and Taiwan. According to Nomura Holdings Inc., in April, China’s iron imports fell 13% year-on-year, copper 4% and car and chassis imports 8% year-on-year.

Russian-Ukrainian influence on supply… Russia’s invasion of Ukraine also disrupted global demand. Boubaker Ben Belhassan, representative of the Food and Agriculture Organization (FAO), said during the UN Informal Interactive Dialogue of the General Assembly for Commodities Markets:

“The ongoing conflict in Ukraine has had a particularly strong impact on the agricultural commodity markets, as the Russian Federation and Ukraine are major exporters of fuel, food and fertilizers. In particular, the increase in fertilizer prices faster than product prices has reduced the affordability of fertilizers and thus their use in production. Decreased exports from the Russian Federation and Ukraine could create a supply shortage in international markets, driving prices higher, thereby exacerbating malnutrition and food insecurity in many countries. In this context, policy recommendations include ensuring open trade in food, fuel and fertilizers, avoiding temporary policy measures such as trade restrictions, strengthening market transparency, diversifying food supply sources and supporting vulnerable groups.”

Strong dollar effect… The strong dollar restrained the commodity demand of developing countries as their currencies fell by 3% on average since April as of May and further decreased as of today. Of the 45 major commodities traded globally, 42 are priced in dollars. The only exceptions are wool (Australian dollars), amber (Russian rubles) and palm oil (Malaysian ringgit). Commodity imports in the emerging economy are also under pressure due to the growing need to use scarce foreign currency to pay off dollar-denominated debt. From 2018 to 2021, Chile’s non-bank dollar debt increased from 34.7% of GDP to 50.3%, Mexico’s from 21.9% to 30.1%, and Turkey’s increased from 23 to 28.2%.

Commodity market as of today… According to the S&P Commodity Futures Index, these main factors have caused commodity prices to drop 20% since 9 June:

S&P-GSCI Futures Index… Source: CME, Yahoo Finance

As we can see, the trend seems uncertain since July. The commodity index seems to have found a consolidation range between 650 and 700. What is certain is that the Macro elements and extreme weather issues are not going away and the worst is to be expected.

Conclusion? The commodities market outperformed all other markets in 1Q22. While several other asset classes have suffered serious declines, commodities have posted impressive gains, attracting many investors looking to offset their losses.

Unfortunately geopolitical events and the COVID crisis in China pose a major threat to this market and 2Q22 commodities has shown that it is not a safe haven in the truest sense. The commodities market, which is down 20% from its annual peak, shows no signs of recovery anytime soon.

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