Will Commodities Strike Back in 2024?

Lower commodity prices have been one of the key factors behind the recent rally in most assets, including crypto; however, this trend may reverse this year.

Commodities Have Been Helpful for Disinflation

After a plunge during the coronavirus pandemic and subsequent recovery, commodity prices spiked in the first quarter of 2022 due to Russia's invasion of Ukraine. Russia is a major producer of most commodities, and large-scale sanctions against it ignited fears of lower commodity supply. However, in 2023, commodity prices declined back to levels before the war.

Bloomberg Commodity Index (USD)

The commodity price drop in 2023 was very helpful for disinflation. In the first half of 2022, the US CPI rose more than the core CPI, which excludes food and energy prices that are highly correlated with commodities; however, it fell much more rapidly in the following months. Headline CPI has been below core CPI since March 2023. As inflation became less of a concern, major central banks were able to halt their rate hikes. This helped stocks, bonds, and crypto. Following the market's reassessment of the future rate path, primarily after the publication of inflation data in October, most assets experienced a historic rally in November and December.

US CPI and Core CPI (YoY, %)

Unlikely to Repeat

Lower commodity prices last year reflected both resilient supply and subdued demand. Sanctions were primarily aimed at decreasing Russia's revenue from oil and other commodities, rather than at reducing the supply from Russia. US oil production rose more than expected, largely offsetting the production cuts by OPEC+.

I believe the weaker global economy played an even more significant role in lowering commodity prices. Europe, China, and most other regions were far less resilient than the US, leading to depressed global commodity demand. For the US, it was a fortunate combination of lower prices for commodities and other globally traded goods, coupled with a still-strong domestic economy. This situation created a sort of soft landing, at least temporarily. The problem is that such a rare combination is unlikely to repeat.

This year, we are likely to face either a hard landing if the global economy continues to weaken, or more synchronized global growth if it improves. China looks to be the key factor deciding between these scenarios, and I think that the China recovery scenario is more likely. Chinese authorities seem to be increasingly concerned about weak growth, and the macroeconomic situation is very conducive to policy support. Unlike most other countries, China faces a deflation threat rather than too high inflation. Deflation makes a perfect case for a large-scale stimulus, maybe even direct money printing like it was in the US after the 2008 crisis.

China CPI (YoY)

Despite the widespread pessimism surrounding Chinese assets, especially real estate, the significant rise in iron ore prices, now at their highest since April 2022, suggests that the economy may be in better shape than perceived. In 2023, iron ore outperformed most metals. Iron ore, primarily used in construction, sees its demand predominantly driven by China.

SGX TSI Iron Ore Futures (USD)

Overall, this year could witness an increase in global demand for commodities, while the spare supply has already been largely depleted. For instance, a significant new copper project in Panama has been recently delayed, potentially for years, and recent comments from shale oil producers indicate that this year's production growth will be much slower than in 2023. 'Demand for raw materials is at record levels, inventories are low, and spare production capacity is largely exhausted,' said Bloomberg, citing Jeff Currie, the former head of commodity research at Goldman Sachs.

Positioning

Importantly, investors are not positioned for such a scenario. Commodities, as an asset class, are currently unpopular and might even be considered a contrarian bet, given that most investors are enamored with tech. The S&P 500's weighting of commodity producers is small. Speculative positioning in most commodity futures, such as copper — a popular commodity due to its role in the energy transition — is low.

Net Speculative Positions in Copper Futures

In the oil futures market, hedge funds and other speculators have reduced their net exposure to levels akin to the lows observed during the commodity crisis of 2015-2016.

Net Speculative Positions in Oil Futures and Brent Oil Price

Considering the bearish positioning, low-cost volatility, and the apparently escalating conflict in the Middle East, I would contemplate a modest, speculative bet on call options for oil.

At-the-Money Implied Volatility of WTI Oil Options

Conclusion

2024 could potentially be a pivotal year for commodities, given the strong existing demand — which might surge if China implements a substantial new stimulus — alongside growing supply risks and currently depressed market positioning. This scenario is generally unfavorable for crypto and most other asset classes. For investors heavily exposed to crypto or US technology stocks, diversifying into some commodity producer stocks as a hedge could be a wise strategy. S&P Global Natural Resources ETF (GNR) is an easily accessible option. For the more seasoned investors, European oil majors and major mining companies appear to be significantly undervalued.

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