Is now the time to invest in commodities?

By: Frank Knopers

Due to the recovery of the global economy after the corona crisis, the prices of raw materials have risen sharply. Due to large-scale support measures and historically low interest rates, the demand for almost all raw materials increased. But is this also the right time to invest in commodities?

Historically, raw materials are still cheap. If we compare prices with the development of the S&P 500 stock index, it seems as if there has never been a better time to invest in commodities. The last rebound in commodity prices was at the beginning of this century, when China's economy experienced an unprecedented growth spurt. These were good times for commodity investments, also because there was too little investment in the sector in the 1990s.

Raw materials are still relatively cheap (Source: Schroders)

Are commodities making a comeback?

For the past decade, commodities have been out of fashion. In the era of monetary easing and ever-lower interest rates, capital flowed mainly into growth stocks in general and technology stocks in particular. The corona pandemic strengthened this movement, as online working became more important. Valuations of technology stocks rose to record highs. The war in Ukraine and the rise in interest rates put an end to this bubble. Investors are once again looking for tangible value and finding it in defensive stocks, as well as commodities.

Credit Suisse credit analyst Zoltan Pozsar even spoke of a New phase in the monetary system, in which commodity-producing countries will play an important role. In a world that is becoming more fragmented and where countries are more dependent on themselves, raw materials will be a Strategic reserve become. And that means more countries will invest in alternative supply chains and build up additional stockpiles. This will give the countries that possess essential raw materials a stronger position of power vis-à-vis countries that have to import these raw materials.

New investments

An upward cycle in commodities follows a period in which investment in the sector is lagging. When commodity prices are low, it is less attractive to invest, as we have seen over the past decade in oil and gas, but also in other commodities. For example, between 2012 and 2020, investment in copper mines fell by 44%. Investment in oil and gas even fell by 52% between 2013 and 2020. Many institutional investors reduced their investments in this sector because it did not fit their ideal image of sustainability.

The characteristic of raw materials is that it takes much longer to scale up production again. And it takes years of preparation before a new gold mine or copper mine goes into full production. This means that the prices of raw materials can rise rapidly if the economy picks up and scarcity arises.

Energy transition

At the beginning of this century, the growth of the Chinese economy created a new commodity cycle. In the coming years, the politically driven energy transition could cause a new raw materials cycle. Europe wants to become less dependent on fossil fuels, which means that there will be much more investment in, for example, wind and solar energy. This requires many raw materials, such as copper and steel, but also silver. Stimulating electric driving means that the demand for raw materials such as lithium, copper, cobalt, nickel and zinc will increase further.

This energy transition can give a strong boost to the commodities market, but there are also risks. The drive to become less dependent on fossil fuels and to invest more in alternative energy sources relies heavily on politics. A very uncertain basis. In an adverse scenario, in which the global economy enters a new recession, the demand for raw materials will actually fall. The copper price is already falling again, as investors take into account a tighter monetary policy from central banks. The prices of other metals also reflect increasing uncertainty about the economy.

Precious metals as a safe haven?

Although commodities appear attractively valued from a historical perspective, some caution is not out of place now. A new boom in commodities requires strong economic growth or a successful energy transition. With the economic outlook deteriorating, the former scenario has become less likely. Whether the energy transition can compensate for this remains to be seen.

The war in Ukraine has shown that raw materials are vital to our economy and that they are strategic reserves that countries can use to exert power. Russia has control over numerous important commodities and uses this position to strengthen the ruble. But whether you, as an investor, can also benefit from this remains to be seen. The economic outlook is currently too uncertain for that. In these uncertain times, it may be wiser to invest in the safest havens, such as Precious metals.

This contribution comes from Geotrendlines

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On behalf of Holland Gold, Paul Buitink and Joris Beemsterboer interview various economists and experts in the field of macroeconomics. The aim of the podcast is to provide the viewer with a better picture and guidance in an increasingly rapidly changing macroeconomic and monetary landscape. Click here  to subscribe.