Will the commodity rally continue in 2021?

As the global economy has rebounded from 2020’s pandemic-induced lockdowns, commodity prices have recovered in tandem. For instance, Thomson Reuters’ broad commodity index has gained +18% just since the start of November. There are a number of underlying macro drivers at play, namely 1) anticipation of a global economic reopening and recovery, helped by the emergence of effective vaccines, 2) the prospect of further policy stimulus (particularly in the U.S.), and 3) a modestly weakening U.S. dollar. Yet, the recovery for commodities has been uneven. While industrial metals have rallied, traditional energy commodities (like oil and coal) have been much slower to recover. This dispersion can be explained by key differences in the underlying drivers behind industrial commodities and energy commodities. 

We think the recovery in industrial commodities, like copper, can continue, given support from both the cyclical growth recovery and accelerating megatrends like digital transformation. We also see additional upside in energy commodities like coal and oil, but longer-term headwinds (like policy shifts to sustainability) should be considered. 

Let’s start with industrial commodities. We think prices will likely remain well-supported into the year ahead, given the ongoing manufacturing recovery, expected stronger growth in the U.S. and China relative to the rest of the world, and the ongoing acceleration of digital transformation and sustainability.

Consider that China is the biggest contributor to the demand of many industrial commodities. In December, Chinese industrial production grew 7.3% compared to the prior year, and capacity utilization (a measure of how much production capacity is being utilized ) rose to its highest rate since 2013. Meanwhile, in the United States, we expect the Biden administration to introduce another round of fiscal stimulus (our base case calls for USD750 billion), as well as unveil plans for more infrastructure spending in the coming months, focusing on 5G and green infrastructure.

With that said, it’s important to point out that some industrial commodities, like copper, are important inputs into digital and sustainable innovations—for instance, copper is used in virtually every major electric vehicle component. Sectors like electric vehicles, electric machineries, and robotics, all continue to grow at a robust pace. Consumers are moving to online shopping, businesses are moving to virtual meetings, and factories are moving to automation— which all points to faster digitalization ahead. 

The case for energy commodities is more nuanced. In the near term, we see further room for upside, but the longer-term shifts to renewable energy will likely weigh on demand to some extent.

In the near term, the global cyclical recovery should boost demand for coal and oil, given the historically positive linkage between economic growth and energy consumption.

Let’s consider demand first. We currently expect the world’s largest economies to have vaccinated the majority of their populations during the second half of this year, opening up the ability for consumers to reengage with high-contact sectors like travel, leisure, and hospitality. This continued process of reopening should offer further support for oil demand, and by extension, prices, which were initially slower to recover. On the supply side, OPEC and its allies have collectively agreed to production cuts of 9.7 million barrels per day in 2020 in response to the pandemic, amounting to a 10% cut to global supply. Putting this together, as oil demand continues to recover and supply remains well-managed, we see higher oil prices into the year ahead (our year-end forecast for Brent crude stands at $65 per barrel).

Yet, uncertainty persists. The recovery in oil demand is sensitive to progress on the vaccination front. A significantly slower timeline for vaccination could push back the timing for the global demand recovery. International travel in particular may be the slowest to recover given the uneven vaccine rollout across the world. It is also unclear whether consumer and business behaviors will be permanently changed by the pandemic. For example, a more lasting shift to ‘work from home’ may reduce business travel demand (in favor of virtual meetings) and reduce commuting needs.

And over the medium to longer term, more global policy commitment to the environment and sustainability agenda will also likely accelerate some structural changes in the energy sector. Over the last year, China, the EU, Japan and South Korea have all redoubled their commitments towards achieving carbon neutrality in the coming decades. The Biden administration, which has already rejoined the Paris Climate Accord, will likely make similar commitments in the coming weeks. This means that long-awaited shifts in energy demand, away from fossil fuels and towards clean and renewable energy, stands to accelerate in the coming years. This should favor energy sources like liquefied natural gas (LNG), wind, and solar over coal and oil in the long run. 

What does all this mean for investors?

Both industrial commodities (such as copper and silver) and energy commodities (such as oil, natural gas and coal) see tailwinds this year. Although industrial commodities such as copper have already moved higher in line with the economic rebound and recovery in risk assets, we see structural support from the accelerated shift towards electric vehicles and digitalization. Cyclically, energy commodities such as oil have lagged and could move higher as services sectors normalize. Other than the commodities themselves, we see two investment implications. Firstly, higher industrial commodity prices are consistent with a bigger tilt towards cyclically-oriented sectors (i.e. industrials, materials, construction, etc.), especially those that also benefit from major structural shifts like digitalization and sustainability. Secondly, from a geographical perspective, we continue to like emerging markets that are highly geared to the global industrial cycle, including China and South Korea, as well as commodity-driven emerging markets such as Russia and Latam economies.

All market and economic data as of January 25, 2021 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.

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INDEX

• The Thomson Reuters/CoreCommodity CRB Index (TR CRB Index) acts as a representative indicator of today's global commodity markets. The CRB measures the aggregated price direction of various commodity sectors, and is designed to isolate and reveal the directional movement of prices in overall commodity trades.