Wellian Weekly 22.06.2020

Commodity Shock

Since the shock of the coronavirus crisis brought markets to their bottom in March, equities have risen sharply, with global equities up 30%, prompting some commentators to query if markets had run ahead of themselves. Most countries are just reopening after lockdown, yet stock markets are around / above levels recorded at the start of the year, when the world was a very different place. Has optimism overshot reality? Is this just a reflection of the tsunami of liquidity that has been unleashed by governments and central banks in the western world?  

The rally hasn’t been confined to equities with commodities also showing sharp price increases in the last month. Both copper and iron prices have risen over 20% in the last month (as at the time of writing) but has this been driven by supply/demand issues, given that we seem to be far from traditional commodity boom territory? For some of the answers, we need to look to China.

Despite the much-talked about shift in China’s maturing economy to become more consumer driven, it remains the biggest customer for major commodities, such as iron, and China also consumes half the world’s copper. Since China began to ease lockdown restrictions in March, it has seen a sharp recovery in construction and manufacturing sectors during the second quarter. Orders had been increasing prior to lockdown, but the rebound saw copper and steel mills operating at above average capacity levels in April. 

Inventories have come under pressure as suppliers scramble to keep up with demand. Some countries have struggled as the spreading coronavirus has impacted production capabilities. Peru’s copper production was down by a third in April as it came under pressure from lockdowns and a reduction in available workers. It has been a similar story in Brazil, which has been unable to maintain its iron production (one reason for prices pushing higher). Meanwhile Australia, the world’s largest exporter of iron, has benefited from better Covid management strategies that have allowed its mines to remain open. 

Also worth mentioning is the impact of the hedge funds, which had been shorting copper as a way of expressing a view on the economy. Generally, it would hold that a weaker dollar benefits emerging markets and commodities, with rising commodity prices leading to higher cost producers to come onstream. In the face of the risk-on sentiment in markets and robust demand from China, hedge funds have moved to close out their short positions. Whether iron and copper prices continue to march upwards is more dependent on a recovery in demand in the rest of the world, as in addition to its own infrastructure projects, a sizeable proportion of China’s consumption would be exported back into the global economy. For confirmation of that, we will have to wait a little longer.


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