Changing commodities

Remember those straightforward days of managing supply and demand? That was the simple way in which we could price all the commodities we needed around the world. Now, however, things seem to be changing, as the old “norms” are being replaced as new factors come into play.

We can of course simply divide the commodity world between soft and hard commodities, but increasingly we are seeing new pressures on their pricing, which previous specialists have not had to take into account. These changes could be a result of climate change, the virus, political uncertainty and instability and of course the broader expectations of the global economy. The combination of a pandemic, major economic heart attacks, meteorological menaces and some political ineptitude has forced change as a matter of urgency. Only now are we being able to see the effect of this – and how we should be reacting.

History is littered with commodity crises. These often occur when investors with seemingly boundless confidence (or stupidity) and deep pockets try to corner the markets for their own greedy intentions. The result was often the opposite, and the brazen speculator astride the market ended up whimpering when the market reacted against them. One of the most famous of such episodes was the humiliation and ruin of the Texan Bunker Hunt brothers, who thought they could corner and manipulate the silver market for their own gain. They didn’t, they couldn’t and they lost –  over $15 billion. And in an aside I found especially ironic, they were born in a small town called El Dorado.

So let’s look at some of the changes affecting these variable but vital assets. We have often been transfixed by the price of oil, and especially since the two great price hikes by the producing nations in the 1970s (the price rose from a mere $3 per barrel to over $40 in the early 1980s). Despite dire warnings, those dramatic moves did not wreck the global economy, but perversely almost certainly sped up the development of any alternative power source to reduce its opioid-like dependence on this black gold.

I sure you will recall more recently how the crude price at one stage reached a peak of over $140 per barrel in 2008, leading to some less reliable politicians to set its value at over $100 a barrel for the purpose of their national budgets – such as President Putin. No one else appeared to be that short-sighted apart from the Scottish First Minister Nicola Sturgeon. Since then we have even seen the madness of the markets pushing the price to a negative for a short trading moment in April 2020. However, reckless budgeting by political leaders of oil-producing nations is nothing new. A development in the planning by many for the end of the carbon fuel era and the realization that the value of once precious oil fields is being written down to zero.

This of course is not going to happen overnight, but environmental pressures have moved carbon concerns from the protestors to the politicians. Soon there will be no oil companies – at least not in their title – as from henceforth, they will be “energy solution” providers without a whiff of burning charcoal to their name. The more credible move though is that of the Saudi government who with its initial sale of part of their national oil company, Aramco, is quite literally selling the family silver, albeit silver that is somewhat tarnished. The Saudi’s are wisely selling tomorrows asset at today’s price. They realised that within a century they could well be sitting on what may have become a worthless lake of oil, and potentially with a negative value because of the environmental risk. So sell it now, keep the money and let the shmucks take the loss.

Then look at the soft commodities. Food-related assets are being far more affected by dramatic and damaging events. From food to water, such assets are having to be re-evaluated as demand for them increases as their reliable sourcing decreases. However, even here accepted views are being questioned as vital crops such as palm oil come under increasing pressure from environmentalists. The need for foodstuffs is not going to decline, but the increasing pressure of environmental issues will be leading to some significant changes in crops, economies and value.

The next theme to look at is the focus on “clean” electricity. We all know how “green” power generation has become increasingly important, but here you can see additional price pressure appearing on certain commodities. From electric cars, to the development of more efficient power grids and far more effective batteries, this has meant that the likes of copper, nickel, silver and platinum are all seeing increasing demand as the entire power process pivots from fading fossils to environmentally acceptable electricity. To meet the targets for climate management, the voracious demand is going to affect these prices.

For investors, therefore, commodities, which are often seen as an outlier for asset allocation, should be taking a greater role in portfolios away from the traditional 60/40 split between equities and bonds. The equity market has been filled with enthusiasm for technology and the post-pandemic bounce, and the bond market is dominated by governments desperately financing themselves with the illusion of quantitative easing. So real assets such as property and commodities will start to attract greater interest. Add to that increasing concern over inflation and we will all need to revisit our views on commodities.

The year 2021 will see a further development in these commodity issues, and we as investors, users or suppliers would be foolish to bury our heads in the sand. As commodities change, so must we.