The second quarter is shaping up to be the best time for commodities in general, even though they have already moved higher in anticipation.
The US and UK are expected to fully open their economies by the summer. This will, therefore, bring a return of demand for a substantial amount of consumer goods.
As the demand for raw materials increases, supply is still being curtailed due to the unabated covid situation in many of the production areas, especially Brazil. The global transportation system still remains unbalanced, with shipping containers piled in ports full of goods that were unable to reach their destination due to covid restrictions.
That means those containers aren’t available to ship goods for which there is demand. Consequently, this drives up shipping prices and makes supply even tighter.
Prices rise but for how long?
Normally, a lack of supply and increasing prices would be an incentive for new players to get into the market. However, everyone understands this situation to be transitory as economies reopen and logistics rebalance.
It doesn’t make sense to invest in a container building facility, or other major logistics processes to take advantage of the higher prices. This is because the short period of high prices might not last long enough to turn a worthwhile profit.
So, we’re likely to see constrained supply and increasing demand over a relatively short period, from now until the start of summer. This might provide some interesting investment opportunities in commodities.
However, there are two, in particular, that stand out for interestingly similar reasons: gold and oil.
The uncertainty around the reopening process is likely to produce some ups and downs in the markets. This is to be expected as investors reevaluate risks as we go through the motions and unforeseen hiccups along the way.
These moves back and forth in safe havens to risk assets could have an effect on both gold and oil, but in opposite directions. Ups and downs in assets provide interesting opportunities to make money. And the combination could be a way to hedge risk over the next couple of months.
For now, we can look at gold as more of a reflation play. And that’s mainly because there is a pretty strong consensus that inflation will rise. (The disagreement occurs between those who expect it to keep rising in the second half of the year, against those who expect it to stabilize).
As a commodity priced in dollars, oil also works as a store of value against potential inflation
Putting the pieces together
Crude has more speculative potential because its price depends a lot on the geopolitical situation.
For now, it appears that Saudi Arabia doesn’t want to restart a price war to gain market share. In fact, most recently, the country repeated its offer to voluntarily curtail production for at least another month.
Many analysts are pointing to $60/bbl as a minimum price that major producers are eager to maintain. This is probably because they all have increased debt from fighting covid, and need to generate additional revenue.
As economies reopen and travel gets underway, we can expect crude demand to increase. Aviation accounts for around 9% of petroleum product consumption, while bunker fuel (used for shipping) accounts for an additional 9%.
Of course, this pales in comparison to the 48% used for road transportation. Regardless, shuttering of international travel and logistics has substantially reduced crude consumption. Which means that, as vaccines are rolled out, that consumption would be expected to increase.
The ups and downs
Worries about the pace of the reopening will change cash flows.
An example of this is the recent decision by Germany to discontinue the use of AstraZeneca vaccine for people under 60.
Investors fearing that the economic reopening will take longer might pull their bets on oil. This would keep the price down. On the other hand, we would expect both gold and oil to get a boost if the economic reopening speeds up, as investors worry about the erosion of value due to inflation.
And even more than gold, a more fungible alternative that is gaining increasing traction are cryptocurrencies. The crypto market, for example, has surpassed the trading portion of the gold market, despite its speculative nature.
Keeping an eye on the prize
Barring unforeseen geopolitical issues (for example, Russia reportedly massing troops across the border from Donbass; or Indonesia threatening to sink Chinese ships in its economic exclusion zone), gold and oil might provide a series of buy and sell opportunities.
And this will likely be the case as the market processes the uncertainty surrounding the vaccine roll-out, the restart of international travel, and the rise of inflation.
Key things to keep an eye on in that scenario are naturally CPI numbers among countries that are most advanced in their vaccine rollout. However, also important is the potential of vaccine passports gaining acceptance, the price of shipping containers, and rising airline load factors.
Then, it’s just a matter of looking for potential divergences between the price of oil and gold, as risk appetite shifts over time.