No different than equity markets, commodities were hit hard with the global economic effects of COVID-19, this placed further pressure on markets suffering from over-supply. There is no worse combination than a demand shock in an environment suffering from large oversupply imbalances or excess production. However, the dispersion in returns have been huge in March and for the year. Energy markets are very different than grains or precious metals.
Commodities are different than financial assets given that inventory builds can spread short-term market imbalances through time. Excess supply today creates contango which allow for storage to play a role in smoothing shocks; however, there are even limits to storage economics. We are reaching those limits in crude oil and refined products. There is real talk of negative oil prices.
Investors need to go back to first commodity principles to create scenarios for this will be resolved. "Low prices are the solution to low prices." When prices reach levels where production is shut, capital finds new places to invest, and excess capacity is rationalized, prices will rise. Second, "commodities are logistics markets." An economic shock may see immediate price declines, but shocks also breaks logistics which will impact the ability to move supply to market. Prices need to rise to adjust logistical disruptions.
- Energy markets are being fundamentally altered with the end of cheap capital for marginal producers, consolidation to stronger hands, and a reconfiguring of geopolitical oil power. The price bottom may not be with us.
- Agriculture markets are not immune from the reworking of energy markets. The corn/ethanol/energy link is going to have to be rationalized. The same can be said for other oils and sugar used for energy.
- Trade logistics are in upheaval. From flows across the globe, dollar invoicing, and EM capital flows for commodity development, global commodity supply chains will change and that will push prices higher.
- Project development will be reassessed even in an era of cheap money. Long-term projects based on poor price projections will be abandoned. Economic development will be impaired.
- The price and supply of labor for agriculture will cut capacity and raise prices. Migrant labor is the driver for fresh food in markets twelve months a year.
While currently in transition, a global economy that starts to recover may make commodities a good alternative to financial assets. This is a radical change from the post Financial Crisis period.