In a record-breaking year for asset prices, gold has grabbed its share of the headlines. After reaching a record high of USD 2,051/oz in early August, gold suffered its largest one-day decline in seven years on 11 August, dropping back below USD 1,900/oz. But we think the bout of profit-taking in gold should be short-lived and believe the appeal of commodities extends well beyond just the yellow metal.
As ample central bank liquidity finds its way into the real economy, we think the conditions are set for a solid and synchronized growth recovery across the world. This should pave the way for a pick-up in commodity demand, particularly in the developed world, while Chinese demand for commodities stays buoyant. Broad commodity indexes have already made solid gains in the third quarter—total returns for BCOM index are 9.9% and 8% for the UBS Bloomberg CMCI. We expect this rally to continue and forecast broadly diversified commodity indexes to appreciate by almost 15% over the next 12 months.
This strength is likely to be based on several key factors: Commodities should benefit as the global economy improves Based on our historical analysis, quarterly commodity returns tend to be higher when economic growth accelerates. In our analysis, returns were more than double when the GDP of advanced economies gained speed during the full 30-plus year sample window. The key message here is that we should not wait until GDP growth in the developed world is back above trend to chase the asset class. While commodities perform strongly in the later stages of an economic cycle, good returns can also be found when economic activity accelerates, even from negative territory. Supply constraints and low inventory levels are conducive for higher prices in several key commodities Oil markets are a notable example. OPEC and its allies (OPEC+) have shown a great deal of unity; global crude oil supply contracted to a nine-year low of c. 87mbpd in June. Given the group’s discipline to maintain their output-cut deal, and with oil demand continuing to recover, the market is undersupplied, and oil inventories are starting to drop.
Beyond energy, we expect copper supply to drop this year by more than 3% due to the COVID-19 pandemic. This supply decline, mainly due to mining issues and a lack of available scrap copper, could also trigger a smaller bounce in supply growth next year as new mine capacity is being pushed out. Finally, as economies reopen further, we anticipate a gradual recovery in demand for key soft commodities such as coffee, cocoa, and sugar. Gold has room to rally further
Gold’s sell-off was driven by a rebound in 10-year real rates after falling to record lows in negative territory. Demand for gold this year has been driven mostly by record inflows to gold exchange-traded funds, so the price reaction was exaggerated and should be seen in the context of the sharp price run-up prior to the pullback. On 17 August gold had already recovered to USD 1,954/oz. With the Fed continuing to suppress nominal rates and inflation expectations rising, we maintain our end year forecast of USD 2,000/oz. In the near term, gold may move as high as USD 2,300/oz, particularly if geopolitical tensions rise.
So, we see a variety of opportunities in the commodity space. Among other recommendations, for broad long commodity positions, investors can consider using second-generation commodity indexes, which aim to reduce the cost of rolling futures contracts. More specifically, we remain positive on a range of precious metals, including gold, silver, and platinum. We anticipate even bigger gains in industrial metals and energy. Specifically, we expect the recovery in oil to continue.For more conservative investors who are able to use options, as an alternative to being long, the pickup in option volatility across all precious metals offers an opportunity to sell puts and earn yield from the option premium. Similarly, in oil, we recommend considering selling puts in Brent crude with strike prices below current levels and with a maturity of six months.
Haefele is of UBS