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What potential could commodity prices offer?

The second of our articles looks at the macro-economic implications for commodities.

Notwithstanding the relatively short-term implications of a trade spat between the US and China, commodity prices could present a more interesting opportunity with a potential background of sustained economic growth.

Current situation

Oil prices have recovered sharply over the past 12 months, boosting overall commodity prices. While this might be good news for oil producers, it has other consequences.

Firstly, it puts further upward pressure on inflation which has already led to an adjustment in the policies of major central banks. In the world’s largest economy, the US Federal Reserve (Fed) has implemented two interest rate rises this year, while also signalling that two more are likely. The Fed’s counterparts in the UK, Europe and Japan are all indicating that inflation is becoming more of a consideration in their thinking which, in turn, affects economic growth as borrowing becomes more expensive in order to keep inflation under control.

Secondly, events in the Middle East have upset what was a balance between supply and demand of oil. The Organisation of the Petroleum Exporting Countries (OPEC) is undergoing internal disagreements as Saudi Arabia tries to push production levels down or up to massage oil prices and meet the conflicting domestic needs of itself and its OPEC partners.

Nonetheless, we are in a situation in which demand and supply are more or less in balance following some severe volatility, notwithstanding the effects of geopolitics. So what can we anticipate?

Short-term volatility

Assuming a politically stable environment, we could reasonably expect steady increases in mineral prices, although this is not guaranteed. While China’s growth will inevitably slow and focus more on the domestic market with a shift towards consumer and service industries, the demand for materials from the world’s biggest consumer will not vanish. Now that prices for the likes of aluminium, iron ore and nickel appear to have bottomed out, ongoing supplies rather than existing stockpiles are going to be more important in meeting the demand of China. That should help to support mineral prices over the longer term.

However, as has been made all too clear lately, stability is not guaranteed. US President Donald Trump is leading a robust campaign to reduce the more than $375bn trade deficit with China1. At the time of writing, the president had proposed tariffs on $200bn of Chinese imports in addition to those already applied to $50bn of imports. Chinese officials have stated their intention to “make strong counter measures”, citing the US policy as “blackmail”2.

Aside from the broader economic implications, the demand for commodities is likely to take a hit. Metals and oil are priced in dollars. As investors reduce their exposure to risk, they look for perceived “haven” investment opportunities such as buying dollars. This, combined with the rising interest rates in the US, drives the value of the dollar up. That makes oil and metals more expensive which can put downward pressure on demand while nervousness reigns. In short, a trade war is bad news as it creates volatility and unpredictability in prices.

More positive longer term outlook

But those are relatively short-term concerns and, as we often iterate, it is important to take a long-term view. A sensible investment timeline would be one of at least 10 years, depending on your personal circumstances, which is designed to help overcome such volatility. Over this longer-term horizon, the outlook is more positive as we feel that commodity prices are unlikely to fall significantly but could post steady increases driven by economic growth in the US, China and beyond. This is borne out by data from the International Monetary Fund which foresees US tax cuts driving global growth to 3.9% in 2019, while US growth itself could register 1.2% through to 2020, falling somewhat thereafter3.

1 Source: US Census Bureau, website accessed 20 June 2018

2 Source: Chinese Commerce Ministry statement issued 19 June 2018

3 Source: World Economic Outlook Update, January 2018, International Monetary Fund

Important Information

Forecasts of future performance are not a reliable guide to actual results in the future, neither is past performance a reliable guide to future performance. The value of investments, and the income from them, may fall as well as rise and cannot be guaranteed. Any views expressed are our in-house views at August 2018. Investment markets and conditions can change rapidly and the views expressed should not be taken as statements of fact nor relied upon when making investment decisions. This information may not be used, copied, quoted, circulated or otherwise disclosed (in whole or in part) without our prior written consent.

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