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A tailwind for commodities

Investors remain optimistic about the economic outlook and the prices of most commodities have advanced significantly since the start of the new year. In some cases, prices were driven up by financial investors. Oil recently recorded the biggest gains, while demand for industrial metals depends on the trajectory of China’s economy. Gold, on the other hand, has limited upside potential in the near term.

Commodity prices have risen substantially since the start of 2021, already factoring in to a large extent the economic recovery that is expected over the course of the year. Commodity valuations thus remain quite high. From a fundamental perspective, very little has changed. Physical demand for commodities remains subdued due to lockdowns, although supply is limited in some cases.

At global level, market participants have become more optimistic. In many regions, hopes are growing that the end of the coronavirus pandemic is near. Vaccination campaigns in Israel, the US, the UK and other countries are in full swing and significant portions of the population have already been immunised. Case numbers are falling around the world despite the emergence of more infectious virus mutations in countries such as the UK, South Africa and Brazil. Local outbreaks in China have also been brought under control. This means that the prospect of a worldwide economic recovery has become more tangible.

Crude oil has the greatest potential in the sector

In December 2020, the price of Brent crude rose above US$ 50 per barrel for the first time since March 2020. This was primarily attributable to purchases by investors. Union Investment’s commodities experts have currently set their 12-month target prices for Brent crude and WTI at US$ 60 and US$ 57 per barrel respectively. However, the price of Brent crude has already climbed to around US$ 60 in the spot market. The disciplined adherence of the OPEC+ countries to their agreed production caps is a key factor in this context, alongside the general optimism about the economy. Member states continue to limit their production volumes and have managed to effectively curb the supply of oil Inventories in the US are being progressively run down.

With regard to the futures market, crude oil remains interesting. In light of the currently inverted futures curve (backwardation) and the associated prospect of positive roll yields, there are good reasons why oil is the commodity of choice. The main sources of risk are a renewed escalation of the pandemic, discord among the OPEC+ members and an increase in US shale oil production.

US oil inventories are gradually returning to average levels

US inventories of crude oil and oil products*

US oil inventories are gradually returning to average levels
* excluding strategic petroleum reserves (SPR) Sources: Refinitiv, Union Investment, as at 12 February 2021.

Industrial metals underweighted

Industrial metals, on the other hand, seem less interesting because the segment is exceedingly dependent on demand from China. The People’s Republic accounts for around 50 per cent of global demand for industrial metals, compared with just 15–20  per cent of global demand for oil. Industrial metal prices are therefore closely correlated with construction and infrastructure activity in China.

The Chinese government had been supporting these sectors with fiscal and monetary stimulus measures for a long time. But lending has been scaled back across the country, not least to prevent the construction and real estate sectors from overheating. And as lending growth is now slowing in China, the waning stimulus effect from the credit supply is also putting a damper on capital-intensive sectors. Although industrial metals should benefit from the economic recovery in western countries, their proportion of global demand is comparatively low. In addition, once economies open up again in western countries, demand can be expected to focus more on services than on goods.

Precious metals attractive in the long term

In January, the US dollar had a dominant influence on the prices of precious metals. By contrast, real US interest rates – the main driver of the gold price over a longer horizon – had little impact in the short term. Market volatility is a third factor. Union Investment expects the US dollar to remain weak in the near term, but believes that the second half of 2021 will bring rising real US interest rates and a stronger US dollar. This would not be a very supportive environment for gold. The 12-month forecast for the price of gold was therefore adjusted from US$ 1,900 to US$ 1,800 per troy ounce.

Silver attracted a lot of attention in recent weeks when private investors developed an appetite for the metal. This drove up the price, which briefly shot to a peak of more than US$ 30 per troy ounce in early February. The global market for silver is only about one tenth of the size of the gold market, which made it susceptible to the concerted action triggered by a viral social media campaign. Due to limited market liquidity, it takes only a relatively small number of purchases to impact the price of silver. The euphoria did not last long, but this purely investor-driven surge helped silver to close the valuation gap to gold, meaning that silver and gold are now priced fairly relative to each other. Silver has the added advantage that it is more widely used for industrial purposes, for example in photovoltaic systems.

The price of platinum recently also went up sharply, boosted by positive news from the automotive sector. Union Investment’s commodities experts believe that platinum has only limited potential in the near term but could catch up with the price of gold over a longer horizon. Platinum is used for a wide variety of purposes, for example in catalytic converters. This segment should see further growth as environmental regulations are increasingly tightened. In addition, other technologies of the future such as fuel cells also use platinum. Cyclically sensitive precious metals (especially platinum, but also palladium) thus continue to offer greater upside potential than gold. All in all, we currently regard the balance of opportunities and risks in the commodities sector as neutral.

 

As at 12 February 2021