For the past year, an incredible commodities mania has swept financial markets. It was led off by the post-COVID recovery which juiced goods demand but limited some supply-side responses.
It then morphed into a narrative of ESG constraints on mining expansions being structural just as enormous demand loomed for the great decarbonisation push.
Then, surging commodity prices themselves helped trigger an inflation panic that Wall Street packaged up as a foolproof argument for buying more commodities.
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We then had the Ukraine war which knocked out a bunch of commodity production from Ukraine and Russia.
This has led to a self-reinforcing bid for every kind of dirt on earth.
The great conductor of the mania was Goldman Sachs, which used the fact that inventories were suddenly declining in all commodities (owing to hoarding by traders) to argue we faced a “molecule” shortage.
The crescendo of the craze was delivered by Credit Suisse’s Zoltan Poszar who argued that commodities were about to displace the US dollar as the global reserve currency as they increasingly underpinned the Chinese yuan.
This craze became so intense that a building recession in China itself – which consumes half and more of most commodity imports – was ignored.
Like all bubbles, there are kernels of truth in these arguments:
- Supply was hurt by COVID.
- ESG has played a role in coal production.
- Commodities are a good inflation hedge.
- Commodity inventories are low.
- The US dollar is everybody’s problem.
However, there are solutions to all as well:
- High commodity prices fix high commodity prices.
- New energy commodities are by and large not needed in large volumes thanks to recycling boosts for cars and other things.
- Commodities are a good inflation hedge, right up until the moment that they collapse with deflation.
- Commodity inventories are artificially low owing to hoarding and then burst into surplus when the crash comes and traders puke.
- Commodities themselves are so volatile and pro-cyclical that making them a new reserve currency underpinning CNY will turn it into an economic wrecking ball for China.
- Not to mention that the Fed has openly declared that it is going to use interest rates to fit demand down to supply come hell or high water. An intensely US dollar bullish argument.
The problem is that commodities are commodities. They are not rare. They are easy and cheap to produce. And they are easy and cheap to recycle.
This is why commodity booms always exhibit the same inverted swoosh shape. They go up the escalator as everybody is slowly drawn into owning them. Then they go down in the lift because eventually, the price signal that sends leads to a lot more commodities.
This is exacerbated by the very inflation dynamic that is triggered as a result.
In short, what Goldman and Zoltan never told you is that commodities are the most violently volatile asset class on earth and a crash when it comes can wipe up years of steady gains in a few short days.
It is my view that that is where we are today.