Copper, steel, aluminum and more: is the super cycle of raw materials already over?

Copper, steel, aluminum and more: is the super cycle of raw materials already over?

To facilitate the transition to renewables, the coming decades will see intense smelting of iron, copper and aluminum ores. Comment by Peter van der Welle, Robeco's Multi Asset Strategist

In the last two years, the raw materials have made sparks. In fact, they are the only asset class for which we have forecast excess returns over the stable returns of the last year.

What we hadn't anticipated, however, was another upside from August 2021, with the GSCI commodity index now up 50% from the peak of the recession in February 2020. cooled since mid-June as cracks in global aggregate demand became more pronounced and focus shifted from inflation concerns to recession risk, as markets began pricing in a faster disinflation path in the wake of aggressive 75bp policy moves by the Fed. Stabilizing medium-term inflation expectations in the US usually reduces demand for commodities as a hedge for inflation.

So far, the returns achieved in the post-pandemic expansion are already largely on par with those achieved at the end of the commodity super cycle of 2001. Does this imply that the commodity super cycle of the so-called “Roasting Twenties” is already over? Looking ahead, in our baseline scenario, we expect commodities to yield similar to a stable 4% government bond over the next five years.

First, we see a relatively inelastic supply in the commodity markets. With tight spot markets, the destruction of demand through high prices will be the main rebalancing mechanism in the coming years. Consumer demand destruction is already underway, and consumers are actively rationing their energy consumption. This rationing process typically reaches its peak when gasoline prices peak before a recession. In the United States, gasoline prices have risen as crack spreads (the difference between a barrel of crude oil and the petroleum products it refines) have widened due to closures and business disruptions in refineries, causing prices to soar for consumers. .

Second, although yield curve reversals have signaled the risk of a recession in the United States, commodities are an end-of-cycle asset that on average sees prices rise between the yield curve reversal and the peak of recession. The increase in the energy bill will anticipate the recession in the eurozone, especially if Russia completely closes the Nord Stream 1 to German customers. The result will be greater global competition for LNG as Europe seeks to break free from Russian gas and gain energy independence in the coming years.

Third, the rise in food prices may continue beyond the next harvest season. Rising gas prices push up fertilizer prices, which causes crop yields to drop, not just this year but also over the medium term, and the soil is further depleted. Furthermore, a prolonged war in Ukraine could hamper grain production, even if the recent agreement signed by Ukraine and Russia on grain exports across the Black Sea holds.

Fourth, with our five-year projection of US inflation at 2.6% – modestly above five-year break-even inflation levels – we believe demand for commodities as a hedge for inflation persists. . Although recessions, which we expect around 2023, are typically highly disinflationary and thus create headwinds for the asset class, we do not anticipate full-blown deflation or deep bear markets in commodities in our baseline scenario.

In our bullish scenario, the reasons for investing in commodities are even more compelling as developed markets continue to grow above their long-term trend rate, with aggregate demand able to sustain higher prices for longer. A lower supply inelasticity compared to the baseline scenario (also because capital costs for mining companies and oil producers decrease thanks to the acceleration of the green transition) contributes to rebalancing commodity markets. With the supply-side contribution, therefore, price increases are less explosive and more sustainable.

Since the countries that represent about 67% of the world's GDP have committed to solving the problem of climate change, we expect a political push to accelerate the transition to green energy and in this wake the demand for "green metals" will increase as copper, iron ore and aluminum. Steel is the main production factor for wind producers: about 84% of the weight of a turbine is made up of steel. According to the IEA, an offshore wind farm requires nine times more mineral resources than a gas plant, while an average electric car requires six times the minerals needed for a traditional car. Electrification requires huge amounts of copper and aluminum.

To facilitate the transition to renewable energies, in the coming decades there will be intense roasting activity, that is, the smelting of iron, copper and aluminum ores. In order to reach the net zero carbon emissions target by 2050, a six times higher input of minerals and metals than the current one is required for renewable energies. Our bullish scenario sees the prolongation of a super cycle inspired by the green transition and generates an expected return of 8.25% over the next five years.

In our bearish assumption, commodities are suffering from a decline in aggregate demand around the 2023 recession, despite safe haven flows favoring gold after the Fed reaches its monetary policy peak. Since supply remains relatively inelastic and the rising cost of capital inhibits the expansion of mining supply, the rebalancing between supply and demand occurs mainly through the destruction of demand. After some respite around 2024/2025 for commodities, when the recovery takes hold, a second round of policy tightening to contain the recovery in inflation will reverse the trend. With a phase of demand destruction even deeper in 2027 than in 2023, commodities see an overall return of -2% in euros over the next five years.

This is a machine translation from Italian language of a post published on Start Magazine at the URL on Sat, 01 Oct 2022 06:19:18 +0000.