Commodities supported by greenflation and tight supply

Crude oil markets look set to tighten further in 2022, with several producers within the OPEC+ group already struggling to meet their allocated quotas. With that in mind and considering US production struggling to reach pre-pandemic levels, we maintain a long-term bullish view on the oil market. It will be facing years of likely underinvestment with oil majors losing their appetite for big projects, partly due to an uncertain long-term outlook for oil demand, but also increasingly due to lending restrictions being put on banks and investors owing to a focus on ESG and the green transformation. 

Global oil demand is not expected to peak anytime soon and that will add further pressure on spare capacity, which is already being reduced on a monthly basis, courtesy of OPEC+ production increases. According to OPEC and the IEA, the early months of 2022 could see an oversupplied market, but with spare capacity starting to run low and demand reaching a pre-pandemic peak, we see Brent crude oil reach into the $90s, and potentially above $100 during the second half. 

Industrial metals rose strongly in 2021, but with most of the 32 percent jump in the London Metal Exchange Index occurring during the first half, the year ended with some degree of uncertainty. After hitting a record high in May, copper spent the remainder of the year trading sideways on continued worries about the outlook for the Chinese economy, especially its troubled property sector. Aluminium, one of the most energy-intensive metals to produce, also rose strongly in 2021, and the outlook remains supportive with supply disruptions at the end of 2021. This adds further fuel to expectations of a growing supply deficit this year, not least considering the outlook for slowing capacity growth in China as the government steps up its efforts to combat pollution, and ex-China producers for the same reasons being very reluctant to invest in new capacity. 

While the energy transformation towards a less carbon-intensive future is expected to generate strong and rising demand for many key metals, the outlook for China is currently the major unknown, especially for copper where a sizeable portion of Chinese demand relates to the property sector. But considering a weak pipeline of new mining supply we believe the current macro headwinds from China’s property slowdown will begin to moderate through the early part of 2022. 

This is supported by the prospect of the PBOC and the government—as opposed to the US Federal Reserve—stimulating the economy, especially with the focus on green transformation initiatives that will require industrial metals. With inventories of both copper and aluminium already running low, development could, in our opinion, be the trigger that sends prices back towards—and potentially above—the record levels seen last year. Months of sideways price action has cut the speculative length, thereby raising the prospect for renewed buying once the technical outlook improves; in HG copper that signal would likely be triggered on a break above $4.50 per pound. 

Precious metals was the only sector suffering declines last year, but considering the headwinds from rising bond yields and a stronger dollar, gold’s negative performance of around 3.6 percent was acceptable from a diversified portfolio perspective. Being the most dollar- and interest rate-sensitive of all commodities, gold will take some—but not all—of its directional inspiration from these two markets. Gold is often used by fund manages as a protection against unexpected events, whether they are macroeconomic or geopolitical developments. The wall of money provided by governments and central banks following the first wave of the Covid-19 outbreak helped reduce macroeconomic risks, while sending the stock market sharply higher. 

Agriculture: The UN FAO’s Global Food Price index ended 2021 showing an annual increase of 23 percent, with the sugar and vegetable oil sectors seeing the strongest rises. While we see some moderation in 2022, climate and weather risks remain a concern at a time when supplies have been tightening. Adding to this is a gas-related surge in fertiliser prices which—together with higher fuel costs—may drive a move towards crops with a lower fertiliser intensity.  

Crops with the biggest upside potential are those supporting growth in renewable fuels, such as corn, soybean oil and sugar, especially considering the prospect of higher oil prices amid capped production. In addition, Arabica coffee—already trading at a ten-year high—may rise further if expectations for an adverse weather-related slump in Brazil’s production come to fruition over the coming months. 

For commodity market–related investment ideas, please take a look at the table in Peter Garnry’s equity market outlook.