A déjà vu of sorts in commodities market

G Chandrashekhar | Updated on June 17, 2021

The five major factors that are driving the market now are the ones that drove the market in 2011-12 as well

Global commodity markets this year are buffeted by a host of factors. After the Covid-19 pandemic enveloped the markets in 2020, destroyed commodity demand and sent prices down, the markets are rapidly regaining their mojo.

From early 2021, prices of many commodities — energy products, various metals and agriculture — have escalated to stratospheric levels. Governments and central banks around the world are loosening fiscal and monetary policies in an effort to revive growth. But inflation expectations, in the process, have risen.

Amidst all this, commodities across the board have seen demand revival, supply constraints and price rallies. All this, thanks to multiple drivers including economic growth, geopolitics, monetary policy, currency and weather.

Grain prices have risen by 30-50 per cent, while vegetable oils have rallied by close to 100 per cent. Sugar has gained 30 per cent. Copper has breached $10,000 a tonne to set a new record. Brent has cut loose to over $75 a barrel and threatening to reach $80.

Is there a sense of déjà vu? Developments in 2020-21 have an unmistakable resemblance to conditions in 2011-12 .

The five major drivers of the market — economic growth, geopolitics, monetary policy, currency and weather — that left their impact on commodity markets in 2011-12 are doing so in 2020-21 as well.

Currently, commodity markets are being driven by the prospect of improved economic growth in 2021 and beyond, especially after large-scale immunisation against Covid in many developed countries. Although not at pre-Covid levels, economic activities this year are reviving for sure, boosting the sentiment and building confidence among market participants.

Although not alarming, geopolitical tensions on the one hand, and improving demand on the other, are seen keeping the energy market buoyant. OPEC+ continues to show exemplary discipline in keeping production of crude oil restrained as per agreement. Sanctions on Iran due to its nuclear programme are still in place. The upside risks to crude oil price from the current levels are real.

Led by the US Federal Reserve, central banks around the world are loosening their monetary policy, expanding liquidity and dropping interest rates in order to revive their economies. ‘Lower for longer’ is the new credo of most central bankers. A part of the low-cost money finds its way into the commodities market. The commodity boom we witness today is substantially liquidity driven.

The US dollar has depreciated in the last one year, especially against the euro. A weaker dollar propels the prices of commodities. The dollar has weakened to 1.21 against the euro from 1.12 a year ago. To be sure, the greenback is showing signs of appreciating.

La Nina weather phenomenon has impacted agriculture since the last quarter of 2020. While South Asia and Southeast Asia received more than normal rainfall, South America had to contend with dry weather conditions. With Brazil and Argentina bearing the brunt of dry weather, harvests of sugarcane, soybean, corn and other crops faced shortfall. This has sent agricultural markets spiralling up in the first half of 2021.

Near identical conditions prevailed in 2011-12. Growth concerns were the same then as well as now. Because of geopolitical tensions, especially due to Iran’s nuclear programme and instabilities in the MENA region, Brent crude went past $100 a barrel, creating inflation risk for many economies dependent on imports.

Easing of policies

To overcome the adverse fallout of the great financial crisis of 2009, the US relaxed its fiscal and monetary policies and resorted to quantitative easing. Infusion of humongous liquidity boosted commodity prices. Copper hit all-time highs that time and threatened to touch $10,000 a tonne.

The dollar had depreciated dramatically and traded at a low of 1.45/€. It took about three years of consistent economic performance in the US for the greenback to regain some of its lost glory.

Weather pattern too was a repeat. In 2011, South America faced La Nina conditions that affected crops such as soybean and cane. Sugar reached multi-decade high of 34.8 cents a pound in 2010 and remained above 30 cents into 2011. Not to be left behind, palm oil rallied to a then record of Malaysian Ringgits 3,800 a tonne due to production deficit for the first time in two decades.

For market participants then, still traumatised by the Global Financial Crisis two year earlier, the regulatory oversight became tighter. The US’ commodity derivatives market regulator CFTC faced challenges because of a vast array of new reforms and regulations mandated under the Dodd-Frank Act. Fortunately, the regulators are not facing any such challenge this time.

India then was growing at 8.5-9 per cent per annum, but faced the biggest risk in the form of inflation led by commodity prices. The period was marked by rise in incomes, including rural incomes, strong consumption growth and steady consumer confidence. The RBI continued to tighten liquidity by steadily hiking interest rates. This time it is different.

The writer is a policy commentator and commodities market specialist. Views are personal

Published on June 17, 2021

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