Current dynamics of Commodity Markets · 2019-10-11 · Lambert Commodities 30 Financialization of...

Lambert Commodities

The current dynamics of commodity markets

Jean-François Lambert

London Business School – 10th October 2019

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Dynamics of Commodity Markets

1. Key Drivers of Commodities

2. Looking Ahead

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1. The Key Drivers of Commodities

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Dynamics of Commodity Markets: Key Drivers

a. Commodities: definition and features

b. The 3 sectors (Agri, Metals and Energy) and their idiosyncrasies

c. Price formation

d. The King of Commodities: Oil

e. Gold – A very special commodity

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Dynamics of Commodity Markets a. Definitions and Features

• Commodities are the essentials

• 3 main sectors: Agri, Metals and Energy

• Common features

ü Strategic by nature

ü Each with a unique nature

ü Market price

ü Mostly traded in USD

ü Future markets5

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Dynamics of Commodity Markets The strategic dimension of commodities

• Rationale for building empires, driving exploration and wars

• A weapon of choice

ü In the 30’s US banning helium exports to Germany

ü In 1973, OPEC prohibiting crude oil exports to Israel

ü In 1979 US embargoed exports of 17mio tons of cereals to USSR

ü In 2010 China stopped rear earth sales to Japan

ü In 2006 Russia stopped gas exports to Ukraine

ü In 2018 China raised tariffs on US Soybeans and cotton6

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Dynamics of Commodity Markets Definitions and Features

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• What is the size of the cake?

Source WTO

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• Commodity trade is worth :

ü 4.5 Trillion USD

ü 25 pct. of world trade

Dynamics of Commodity Markets Definitions and Features

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Dynamics of Commodity Markets b. The Three Sectorsi. Agri commodities (aka “Softs”)

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• Cereals: ü Grains : Corn, Wheat, Barley, ü Rice

• Oilseeds:ü Soybean, Palm Oil Rapeseed

• Other Softs:ü Cocoa ü Cotton ü Rubber ü Coffee ü Sugar

• livestock

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Dynamics of Commodity Markets The Three Sectors - Agri

Specificities of Agri Commodities• Demand is foreseeable

ü Demographyü Urbanisationü Food habits

• Supply is the driving factor

ü Climate and environmentü Crops diseasesü Research and technologyü Policies

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• When deflated, Food and Agri sub indexes, are flat over a long period


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ii. Metals (and minerals)

Dynamics of Commodity Markets The Three Sectors

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• Base Metals (Raw commodities and Industrial Metals)

ü Raw: Iron Ore Coking Coal

ü Ferrous: Steel

ü Non-Ferrous: Copper

ü Aluminium Nickel Zinc Lead Tin

• Minor Metals: 27 metals e.g. Cobalt Lithium Titanium

• Rare Earth: 17 metals – neodymium, dysprosium etc

• Precious Metals

ü Gold Silver Platinum Palladium

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Specificities of Metals• Demand is the driving factor

ü Economic development ü Urbanisationü Chinaü Electric Vehicles

• Supply is driven by long term trends

ü 5 to 7-year lag time from investment to productionü No foreseeable “peak mineral” phenomenonü Technology

Dynamics of Commodity Markets The Three Sectors - Metals

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Share of total demand:China vs the World

Source: Macquarie Bank15


(Source Macquarie Bank)

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China vs the United States:The largest economy is not the most

influential as far as commodities

Source: HSBC

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iii. Energy

• Supply driven dynamics

• The Key Contenders:

ü Oil………………. 34pct.

ü Coal………........28pct.

ü Gas……………… 23pct.

ü Renewables….. 4pct. (% of Primary Energy Consumption in 2017 – BP Energy Outlook 2019)

Sources BP Energy Outlook 2019


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Dynamics of Commodity Markets The Three Sectors - Energy

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Sources BP Energy Outlook 2019

• In 2040:

ü Oil………………. 27pct.

ü Coal………........20pct.

ü Gas……………… 26pct.

ü Renewables… 15pct. (% of Primary Energy Consumption in 2040 – BP Energy Outlook 2019)

Lambert CommoditiesSources BP Energy Outlook 2019


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Lambert CommoditiesSources BP Energy Outlook 2019


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• How to assess the weigh of the 3 sectors?

ü By value? By volume?

ü One lead: Weight in trade (RICI)


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• Agri 35 pct.

• Metals 25 pct.

• Energy 40 pct.


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• Agri 41 pct.

• Metals 20 pct.

• Energy 39 pct.


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• Agri 22 pct.

• Metals 15 pct.

• Energy 63 pct.


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c. How commodity prices are formed?

• The Fundamentals: Physical supply and demand

• The relationship with the dollar


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Dynamics of Commodity Markets Price Formation and USD

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• Correlation is historically tight, but not necessarily all the time

Source Capital Economics

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How commodity prices are formed?



• Oil price

Dynamics of Commodity Markets Price Formation

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• Commodity indices are strongly influenced by the oil price

Source S&P Dow Jones Indices

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How commodity prices are formed?



• Oil price

• Financial markets: commodities are an asset class

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Financialization of commodity markets


• $344bn AUM in commodities in 2018 (RBC Capital Markets by FT Sep 2018 )• Hedge Funds exposure in commodities est. $80bn AUM as of Aug 2019 (Evestment)• Unlisted natural resources AUM has grown from $175bn in 2009 to $668bn in June 2018 (Preqin Feb 2019)• Investors attracted by low correlation to other classes… Is it still the case?


• New financial players : risk premia investors with no interest in fundamentals.

Financialization of commodity markets: new challenges for physical traders

Source: Financial Times



• New financial players : risk premia investors with no interest in fundamentals

• Algorithms and quants are now supporting traders. According to CFTC:

ü 2/3 of CME crude oil future contracts are now automated

ü Almost 50pct of soybean contracts

ü 54% of precious metals contracts

• Growing distortions between prices and fundamentals. Hedging more difficult.



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• The bulk of commodity trade (physical and futures)

• Prices of other commodities are highly correlated

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COE REXECODE COMMODITY INDICES

Source Cercle Cyclope

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Dynamics of Commodity Markets Oil

• Commodity indices are strongly influenced by the oil price

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• Dominant weight in various indexes (59.5pct. in GSCI)

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• Dominant weight in various indexes (59.5pct. in GSCI)

• The most liquid financial market

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Source Bloomberg

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• A Supply driven commodity… Demand follows economic cycles

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Dynamics of Commodity Markets Oil: Features


Dynamics of Commodity Markets Oil: Supply vs Demand

Source International Energy Agency

• Demand growth by 1.3mbpd in 2018, 1.1mbpd in 2019 (IEA).• Supply growth by 2.2mbpd in 1Q2020 (IAE)• Supply reached 100mbpd in September 18, +2.6mbpd over 2017, (IEA)

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• Conventional vs unconventional: the new normal

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Conventional vs non-conventional: opposite dynamics• Opposite dynamics:

üConventional producers rely on high capex with relatively low opexüShale producers run an industrial process with low capex but high opex.

• Prices are kept in check between conventional and shale oil producers: the shale band• Turning on and off spigots: what is easy for shale is tricky for conventional prod• At the right price, “Shale boys”’ production will rise fast• US shale producers are the new swing producers.

üLogistic in the US is a limiting factor. For now üthe looming risk: an environmental problemüthe unspoken issue: profitability?

Dynamics of Commodity Markets Oil: New dynamics of Shale

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The Shale Revolution in the USLTO= Light Tight Oil (Shale)

Source IEA Oil 2019 Report

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US is the first producer of oil

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Source IEA Oil 2019 Report

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World Largest Oil Producers

Source Bloomberg


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• The importance of stocks and reserves

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Source BMO, Sep19

Dynamics of Commodity Markets Oil: Inventories matter


Dynamics of Commodity Markets Oil: Inventories matter

Sources BMO Capital Markets Research

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Viable Oil Reserves• Peak oil is now widely construed as the date when demand of oil will decline.

• Originally the world’s concern was about the availability of oil supply. Such was what peak oil meant until the EV

revolution shuffled the cards.

• Yet liquid demand is likely to continue to grow - at least till 2040 (BP 2019 Energy outlook)

• Supply is ample, but very sensitive to price.

• Whilst the focus is on demand, supply is still the most important factor. Too low a price and supply dries.

• This is why oil price cannot remain lower than 50$ pbl too long. Mechanically, supply will dry up and as demands

bound to grow in sync with economic development, price will immediately rebound.

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Viable Reserves vs

Oil Price: an

illustration

Oil Price

Per Country Reserve Breakdown btw viable &

unprofitable at the highlighted oil price

World Reserves: 1,739 bn barrels

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c.40$ pbl, viable world Reserves would shrank to 561 bn barrels:

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• The importance of stocks and reserve

• Rise of non fossil energy. A long-term play which fuels speculation

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• A long-term play but…

ü EV hype

ü Coal ban

ü Renewables push

ü Geopolitics )

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• The importance of stocks and reserve

• Rise of non fossil energy. A long-term play which fuels speculation

• The geopolitical dimension

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• Besides fundamentals, Supply is now more politically driven than ever

ü Opec/Nopec cuts by Saudi and Russia

ü Sanctions against Iran, Venezuela

ü War in Libya, Iran

ü Terrorism

ü The trade war with China

• From politics to the economy: Is it still “the economy, stupid”?

• Can geopolitics derail the world economy?62

How Geopolitics can change market perception?

Lambert CommoditiesSource FinViz

OPEC Price management

Commodity super cycle

Financial crisis

ReboundOPEC Price management

Cuts


Historical Perspective

The New Normal

Market forces

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Trade War

Back to New Normal

OPEC Price management

Commodity super cycle

Financial crisis

ReboundOPEC Price management

The New Normal Cuts

US Tight Oil Rising

Lambert CommoditiesSource FinViz


A Shorter-term Perspective

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Impact of attack on Saudi

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e. Gold, a very special metal: commodity and /or a quasi currency• A mirror to USD, but not always a perfect one

Dynamics of Commodity Markets Gold

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Source Capital Economics


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• A mirror to USD , but not always a perfect one

• A Market arbitrage tool


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Sources Capital Economics

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• A geopolitical beacon


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• Gold is the best hedge against conflicts


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Sources Capital Economics

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• A key play for central bankers


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Sources World Gold Council


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• A key play for central bankers

• Yet, physical demand is strong in India and China

• And like other precious metals, a technological play


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Sources World Gold Council


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2. Looking ahead

a. The Backdrop

b. Long Short game

c. Final thoughts

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Dynamics of Commodity Markets a. Backdrop

Geopolitics vs Economy

• Trade weaponized

• De-globalisation?

• Will the world fall into the Thucydides trap?

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The world economy under pressure

77Source IMF

“The global economy is now in a synchronized slowdown”(Kristalina Georgieva, IMF Managing Director, 8th Oct 2019)

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Trade keep slowing down

78Source WTO

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Dynamics of Commodity Markets d. Long Short Game - March 2019

• Agri:

o Long sugar

o Short palm oil

• Metals:

o Long gold

o Short iron ore

• Energy:

o Short oil79

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Dynamics of Commodity Markets d. Long Short Game – October 2019

• Agri:

o Long sugar

• Metals:

o Long gold (geopolitical view)

o Long copper (long view)

• Energy:

o Neutral oil (economic outlook vs geopolitical stance)

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Dynamics of Commodity Markets c. Final Thoughts

• Disruption is spreading.

o Towards a weaker growth environment

o Relationship between China and US will remain tense

• Commodity markets should remain challenged.

o Fundamentals tied up to slowing economic growth

o Do not offer a safe heaven as an asset class with the exception of Gold

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A word of caution:

Predictions tend to be wronged as soon as made, so a contrarian

view to all the above might be wise!

Dynamics of Commodity Markets Final Thoughts

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Current dynamics of Commodity Markets · 2019-10-11 · Lambert Commodities 30 Financialization of...

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