Commodity Returns

Posted By Darren Winters on Jan 20, 2021


Commodity Returns

Commodity returns over the last decade (2011-2020) tell a story of currency debasement, or monetary inflation, the rise of ESG investing with particular emphasis on reducing the human carbon footprint, and climate change or erratic weather patterns, which also have an impact on food commodity returns.

Macro trends, defined as long-term directional shifts, have impacted commodity returns since 2011. Moreover, they are likely to impact commodity returns going into the next decade

With this in mind, let’s zero in on future commodity returns.

Financial markets have witnessed unprecedented monetary easing in the wake of the 2020 pandemic great lockdowns, which has snowballed the global economy into a depression. It is worth noting that the global economy was already stumbling, which was underscored when the Repo rate spiked in September of 2019 from 1.89% – 1.95% average rate to 10% in just one week. The Repo rates are the daily rate at which commercial banks borrow money from each other. 

If banks were confident about the state of the economy and the quality of their loans, the Repo market crisis would not have played out in September 2019

Commodity Returns

Put simply, the fact that banks demand higher lending rates amongst each other was a warning of things to come. So more central bank liquidity was on its way, to tame the Repo market. Then the pandemic great lockdowns wreaked havoc in the first half of 2020, and the central banks had a perfect reason to come to the rescue with even more liquidity. Indeed, the global money supply exploded by $20 trillion in 2020. 

With financial markets so financialized US yields collapsed below 1%, the USD dollar lost its luster, and commodity returns, particularly precious metals, gold, silver, and palladium hit a sweet spot. 

The opportunity cost of owning precious, which is the foregone loss of income from owning other safe-haven assets, US treasuries, yields, and interest on deposit accounts became insignificant in 2020. Moreover, fear of currency debasement, due to the Fed’s unprecedented liquidity injections triggered positive capital flows into precious metals. So, silver appreciated 47.89%, gold 25.12%, and palladium 25.86% in 2020. In short, the 2020 precious metals rally was a story about low opportunity costs and monetary inflation. 

Commodity return, particularly in precious metals, could experience a retracement, a temporary reversal, albeit in the first quarter of 2021

As economies open up with fears of the virus subsiding due to vaccinations and or herd immunity, there will be some type of pent-up demand. People are going to want to travel, see friends and family again and do things that they put off during the pandemic lockdowns. If we look at the history of previous pandemics, what followed was a mini economic boom. Moreover, the US Senate is likely to approve a 1.9 trillion USD public spending and the Fed continues to accommodate with monthly purchases of $120 billion in Treasury and mortgage securities and keeping rates low.

Trillions of public spending supported by accommodative monetary policy and some kind of pent-up demand in a post-pandemic economy could be bullish for commodity returns going forward

But precious metals price could be hit from rising US treasury yields as demand for risk assets rise and rising US dollars due to Fed speculation about a pending rate hike.

So, an anticipated increase in economic activity could already be reflected in the Copper price of 3.6 USD, at the time of my writing this piece. Copper was up 26% in 2020. 

But what happens if the economic recovery, which could be already factored into current asset prices, ends up being a dead cat bounce and the Fed hikes rates to keep inflation below its mandate of 2%? 

The recovering US dollar could be a headwind on commodity prices

The consensus trade is that the dollar will fall, but I think it is wrong. My fifty cents worth is that the Fed will want to keep the US dollar attractive so that it can monetize its newly issued 1.9 trillion dollars of treasuries to foreign investors. No investor will want to own treasuries, even if yields rise to say 2% if the Dollar Index is depreciating 10% per year. Put simply expansionary public spending, and accommodative monetary policy walks lockstep with keeping the US dollar attractive.

If you think the Fed is going to let capital flows into unregulated cryptocurrencies continue in 2021, I have got a bridge in London to sell you. 

This could be the year that the regulators regulated cryptocurrencies out of existence, followed by the central banks’ version of cryptocurrencies.

The king of fiat currencies wants to keep TINA alive, which is the capital’s equivalent of a lockdown. Investors have nowhere to go but to buy the debt, which supports 

new world order state capitalism, and the absolute control of rule by fiat system. I am starting to think that democracy could be a fraud, and freedom of choice is maybe an illusion. 

Back to commodity returns, if the USD appreciates, yields rise, and rates increase, that is negative for precious metals, albeit in the short term.

In fact, a rising US dollar tends to be a headwind on future commodities.

There in lies the crux of this piece in determining future commodity returns is whether the US dollar will continue to depreciate in 2021 or will we see a trend reversal in the dollar heading into the year. In eagerness to normalize monetary policy the Fed could hike rates and that would be bullish for the US dollar but bearish for commodity returns, particularly precious metals. 

Typically, the US dollar direction and commodity prices are inversely related. So, a rising dollar is bearish for commodities and vice versa. 

Remember that the consensus trade, that the dollar will continue to depreciate, is often wrong. In a zero-sum game, it is how the few big winners make money from the many losers.

If you can get the trajectory of the US dollar right, then you are likely to be on the winning side of commodity returns going forward

Alpha commodity returns are likely to be those commodities that encompass more than one of the macro trends I outlined above. 

See the Periodic Table of Commodity Returns (2011-2020).

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