Vijay Kumar Gaba

I have been tracking the news flow and experts’ opinions regarding the developments in global commodities markets for the past couple of years. Of course, I am a novice in matters of global economics, trade, and finance; but the commodities markets are particularly something I could never understand.

From my elementary understanding of economics and human behavior, I understand that aging demography, deeper & wider penetration of dematerialization & digitalization in human lives, rising awareness about climate change, and deteriorating growth potential of the developed economies, and perhaps China also, definitely do not augur well for the commodities’ demand in the long term (10-15yrs). However, the opinion of experts is overwhelmingly in favor of a bull market in commodities in the short term (2-5yrs).

The key arguments presented by experts in favor of a bull market in commodities could be summarized as follows:

(a)   Energy prices have corrected back to the pre-covid period. European power prices, US gas prices, natural gas prices, coal prices, and crude oil prices are back to more “normal” levels. The latest inventory, consumption, and production forecasts for 2024 and 2025 are indicating further easing in energy prices over the next couple of years. Energy being one of the major costs in the production of commodities, lower energy costs and adequate supply is a bullish argument for commodities.

(b)   Focus on the use of clean energy, particularly for mobility and electricity production, is changing the demand mix for metals. The demand for metals like copper, aluminum, lithium etc. is rising much faster than the supply. The stockpiles are diminishing fast.

(c)   Commodity producers, mostly emerging economies, are getting stronger in global strategic balance. The expansion of BRICS to include more commodity producers in the emerging market alliance is just one instance. These economies are now in a much better position in determining the terms of trade, which are dominated by the financialized developed world in the extant global order.

(d)   The geopolitical conditions are worsening. Presently, two fronts (Palestine and Ukraine) are witnessing open war. The fear is that more fronts could open in the next couple of years as the political stands are hardening and no one is showing signs of backing out. Wars have been traditionally bullish arguments for commodities as demand for war equipment and reconstruction work need more metals and building materials.

(e)   There is not much consensus on this point, but a strong view is that USD as a global currency may have peaked and could potentially see a steady decline over the next many years. The share of global trade invoiced in USD terms and USD reserves of global central bankers have witnessed a consistent decline in recent years. Moreover, the cross-border flow of funds from the US has witnessed a sharp rise in 2023. Unsustainable US public debt has led to a downgrade of the US sovereign rating outlook. Besides, the trade conflict with China has led to a conspicuous shift of technological advantage from the US to China. These trends may consolidate the position of commodity-producing emerging economies enabling them to seek favorable terms of trade.

(f) Bloomberg Commodity Index is presently at the same level it was in November 1995.

I have avoided investment in commodity producers for a few years now. I think more study of trends in the commodities market, and a review of investment strategy is due.

 Three-month future price of copper at COMEX has corrected almost 27% ~US$3.61/lbs from US$4.95/lbs at the end of February 2022.

Moreover, the discount between spot prices three months future at LME widened to the largest since 2006, indicating poor outlook for copper demand in the near term.

Copper prices have fallen over 10% in the past one month alone on disappointing growth data from China. The hopes of a sharp recovery in Chinese growth in near term are fading as more downgrades are indicating. Goldman Sachs reportedly revised its average copper price forecast for 2023 by over 11% to US$8698/t from US$9750/t earlier. Though the optimism over Chinese growth and consequent firmness in copper prices is not lost completely. For example, Bank of America is still maintaining its US$10,000/t copper price forecast for 2023 end in the hope of large demand ramp up as China accelerates spending on its power grid. Nonetheless, the general mood is drifting towards accelerated slowdown in demand.

Since copper is used in infrastructure (power, shipping, buildings etc.) machinery and discretionary consumption (housing, vehicles, appliances etc.) its demand is widely accepted as a lead indicator of the direction of the economy. For its ability to provide a correct prognosis of the health of the economy, the bright metal is popularly known as Dr. Copper.

So, if the latest prognosis of global economy by Dr. Copper is correct—

·         We shall see an accelerated slow-down in global economic activity with little support from China, in the next few months. This shall reflect in poor export demand for India also.

·         The inflationary forces may weaken as tighter money constricts demand further; eventually leading to the next round of monetary easing by the end of 2023 or early 2024. RBI’s growth forecast for FY24 may also get moderated resulting in change in the present “withdrawal of accommodation” monetary stance.

·         Deflation, rather than inflation, could again emerge as the major concern of global policy makers by the end of 2023. Japanese markets that have majorly outperformed the developed peers on easing deflationary pressure could again face pressures.

·         Notwithstanding the Debt Ceiling tantrums and political rhetoric, for global investors bonds may emerge as preferred asset class in near term over equities.

·         Overall, a foundation for a decent equity rally in India over 2024-25 could be laid in the next 6months.

(Inputs from Copper price slides as global demand drops sharply published in the Financial Times)

 The past 10yrs (2013-2022) have been a period of great uncertainty and turbulence for the global economy, financial system and markets which were considerably weakened by the global financial crisis in the preceding five years.

Supported by abundant liquidity and lower rates, the markets weathered Tapering 1.0; Brexit; Covid-19 pandemic; Sino-US tariff war; remarkable shift in weather patterns; handing over Afghanistan to Taliban; Russia-Ukraine war; out of control inflation; and burst of technology stock bubble rather well. The end of near zero rate regimes and monetary tightening in the past one year has however made the markets jittery.

The current generation of the market participants (investors, bankers, analysts, intermediaries, and policy makers etc.) who are in their 20s and 30s have never practically experienced persistently higher inflation and consistently rising interest rates. They might have read case studies of the 1970s and 1980s era; but that is usually not a good substitute for personal experience. No surprise that their response to the situation, in terms of strategy, has so far not been adequate.

Despite historically low rates and unprecedented liquidity, the economic growth has been dismal and returns on various asset classes are not commensurate with the risk involved. Emerging markets which are usually beneficiary of lower rates and easy liquidity conditions have struggled, in terms of growth, asset prices and price stability.

Commodities performance subdued

Commodities that are considered proxy to growth, e.g., copper and crude oil, have fared poorly over the past decade despite near zero rates and abundant liquidity. Nymex crude oil prices have yielded a negative 2.3% CAGR; while copper has growth at a CAGR of 2.5%.

During 2020 we saw a massive anomaly in crude markets when Crude Oil futures traded at a massive negative US$37/bbl price for a day. Similarly, the Russia-Ukraine war and subsequent NATO sanction on Russia, created massive uncertainty over availability of gas to major European countries, sending them on a gas hoarding spree. Natural gas prices rose over 100% within 6months of the beginning of war; only to correct 80% from the recent highs closer to 2020 Covid lows.

India has held well

In all this turbulence and mayhem Indian economy and markets have held up strong and steady. Though things have been challenging in the past six quarters; over the past decade Indian assets (Equities, INR gold, bonds and USDINR) have yielded decent returns, outperforming most emerging markets and developed market peers.

The benchmark Nifty50 yielded an 11.3% CAGR in local currency over the past 10yrs. Even in USD terms, it yielded a decent 7.7% CAGR, much better than Chinese, Japanese, and European equities. USDINR depreciated at a CAGR of 3.4% over the past decade, making it one of the most stable currencies amongst larger emerging economies.

Cryptoes emerging as popular asset class

Cryptocurrencies have emerged as a major asset class over the past one decade. The value of the top cryptocurrency, BITCOIN, has grown at a CAGR of ~75% over the past one decade. Of course, given the poor understanding, still lower acceptability and strong challenges from governments, central bankers and traditional bankers, the volatility in prices of cryptocurrencies has been extremely high. Of late we have seen gradual rise in acceptability of Bitcoins.

A number of unscrupulous and untested business models emerged in trading, custody, and/or otherwise transfer of cryptocurrencies; causing tremendous losses to the unaware and greedy investors. This may reduce over a period of time as acceptability and awareness about cryptocurrencies improves.

Trend may continue in medium term

Currently a number of developed economies are struggling with demographic challenges; massive monetary overhang; unsustainable public debt; geopolitical tensions, and leadership vacuum. On the other hand, the Indian economy is gaining strength on the back of a favorable demography; disciplined fiscal; exemplary monetary policy; a decade of massive investment in capacity building, especially in physical infrastructure and import substitution (also see Time for delivery is nearing). It is therefore likely that Indian assets may remain steady and offer decent returns over the next decade also.

After almost 5300years, the human civilization may again be entering a copper age. In the Copper Age 1.0 (which mostly occurred between 4500BC to 3300BC) the human transited from stone age to metal age. Copper age was just before we learned to mix tin with copper to make bronze, a stronger metal to be used for hunting tools. A variety of research shows that the invention of first proper round wheel may have happened in this period. The wheel was initially used primarily for pottery and children toys, before it was used in vehicles to transport man and material. Copper age therefore is considered to be an important watershed in evolution of human civilization.

A strong consensus is evolving amongst global expert that acceleration of climate change efforts mean that human may be entering Copper Age 2.0, as the “Red Metal” shall play a critical role in decarbonisation of global economy.

As per a recent research note of Goldman Sachs, “The critical role copper will play in achieving the Paris climate goals cannot be understated. Without serious advancements in carbon capture and storage technology in the coming years, the entire path to net zero emissions will have to come from abatement - electrification and renewable energy. As the most cost-effective conductive material, copper sits at the heart of capturing, storing and transporting these new sources of energy. In fact, discussions of peak oil demand overlook the fact that without a surge in the use of copper and other key metals, the substitution of renewables for oil will not happen.” The report further notes that “At the core of copper’s carbonomics is the need for the world to shift away from a production system based on the chemical energy of hydrocarbons (oil and gas), to one based on a range of sustainable sources – electromagnetic (solar), kinetic (wind) and geothermal. Copper has the necessary physical properties to transform and transmit these sources of energy to their useful final state, such as moving a vehicle or heating a home.”

ING’s research team noted that “Copper seems to be marching towards the peak from its previous cycle thanks to risk-taking and inflation fears. The red metal’s constructive fundamentals, and green narrative on the demand side, seem to be reinforcing the bull run. Given that policymakers seem to be allowing the economy and markets to run hotter, we see further upside for prices near-term.”

ING research further highlighted that “Macro tailwinds, combined with copper's constructive fundamentals and a 'green' narrative in medium- to longer-term demand, could see upside risks dominate for copper…suggesting the red metal could be on a parabolic run, testing previous highs.”

A senior executive at BHP, one of the largest copper producers in the world, was quoted as saying that surging demand for green renewable energy implies that “To keep pace with these mega trends, copper production will have to double over the next 30 years.”

No surprises that copper prices in global markets have risen more than 85% in past one year.

The Goldman Sachs’ note cited above notes that “Crucially, the copper market as it currently stands is not prepared for this demand environment. The market is already tight as pandemic stimulus (particularly in China) have supported a resurgence in demand, set against stagnant supply conditions. Moreover, a decade of poor returns and ESG concerns have curtailed investment in future supply growth, bringing the market the closest it’s ever been to peak supply.”

Are we prepared

Insofar as India is concerned, we mine about ~0.2% of global copper concentrate and contribute about ~4% to the total global copper production. The three major players Sterlite Copper, Hindalco Industries and Hindustan Copper dominate the copper industry in India. The copper production in India has been declining for past years, mainly on account of legal issues; whereas the consumption is rising. The reliance on imports therefore is rising.

The moot point is how do we prepare for Copper Age 2.0? At present it seems that Copper and Natural Gas imports will replace the Crude Oil imports. We might therefore continue to remain vulnerable on trade account and energy security.