Midyear outlook: Commodities

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Rising global tension and gold vs. crude, copper, commodities

The heating-up geopolitical impasse with the world’s largest commodity importer — China — at the center may not be good for prices, with the notable exception of gold. If the US stock market can stay on a tear in 2H, commodities could stabilize, but risk vs. reward appears tilted toward deflation that’s worthy of inflation when equities have some typical retracement.

Unfavorable stage of typical commodity cycle

Russia’s invasion of Ukraine showed the value of partial allocations to commodities, but the high-price hangover may be lasting if history is any indication. Absent unforeseen supply shocks, commodities are on track to do what’s typical — gravitate toward break-even costs. In the US — the largest crude-oil and corn producer — breakevens are about $55 a barrel and $4 a bushel. Growing supply overhangs are normal due to price incentives, as evidenced by the migration toward normal contango from extreme backwardation.

Through June 27, the Bloomberg Commodity Spot Index is up about 6% in 2024, on the back of a gain of about 16% for the S&P 500, which may show divergent weakness in most commodities to the AI-driven stock market, with gold an exception. Our bias is risk vs. reward is leaning toward commodity deflation in 2H.

China in decline and commodity autocorrelation

The Bloomberg Commodity Spot Index (BCOM) could be on a reversion path similar to the aftermath of the 2011 peak, with a big difference — China in decline. About unchanged on June 27 from its 2011 high, the BCOM may be elevated compared with a drop of about 25% in the Hang Seng Index and about 160 bps in China government bond 10-year yields. That commodity underpinnings appear increasingly dependent on OPEC supply cuts, monetary and fiscal stimulus in China, a rising US stock market and a weaker dollar may suggest a tilt toward a typical low-price cure cycle.

The high-price affliction from the 2022 peak may remain a primary broad commodity headwind in 2H. Our graphic shows the BCOM at risk of falling 40% to revisit its uptrend line from 2009. It may take unforeseen forces for it to sustain above its 2011 high.

Risks of a bit of normalization and deflation

Bitcoin atop our annual performance scorecard at the end of 1H and the Bloomberg US Treasury 20+ total return index on the bottom may show some reversion in 2H. If commodities follow a normal path toward a low-price cure and elevated risk-assets back up a bit, the tilt may be toward deflation worthy of the inflation that drove 2022’s highs. Recessionary trajectories in rising US unemployment, waning demand for diesel, gasoline and containerboard, along with sinking China government-bond yields, may portend severe deflation, a US stock-market correction away.

The fed funds rate about 2% above the Consumer Price Index is restrictive vs. the 20-year average of minus 1%, but rising fiscal deficits appear unstoppable, which keeps our bias toward gold extending its rise in 2H vs. most commodities and perhaps vs. equities.

What stops gold from beating most assets in 2H?

Up about 20% on a one year basis, gold is a close contender to the AI-driven S&P 500 and if the stock market has a bit of back-and-fill typical of bull markets, the metal may take the medal in 2H. Our graphic showing the least supply-elastic precious metals on the top of the annual performance scorecard and the most elastic grains on the bottom makes sense about two years after the leaders of China and Russia declared their “unlimited friendship,” and the invasion of Ukraine. It’s a question of duration and unless there’s a Corn Belt drought, we see grain prices heading lower due to an overhang of supply, on the back of the price spikes to the 2022 highs.

Conditions are similar in crude oil and natural gas. Base metals appear at risk of following plunging China government bond yields, which may leave gold to shine in 2H.