As the global economy recovers from the pandemic-induced recession from last year, demand for goods and services are picking up briskly.
That has driven inflation higher but doesn’t explain the elevated inflation that we have been seeing over the past year. A series of supply disruptions account for much of the price increases.
The market has been repeatedly surprised by the strength of inflation.
While many asset classes are good at hedging ‘expected’ inflation - inflation driven by strong demand - there are few that are historically as good as commodities at hedging against ‘realised’ inflation.
Supply shocks, such as the shortage of natural gas are reflected in the consumer purchase index basket through higher energy bills and also in the commodity basket indices through the tracking of natural gas futures prices.
Similarly, droughts which reduce crop yields tend to increase food prices and the agricultural components of commodity baskets.
In 2021, we have witnessed multiple supply-side shocks that have propelled both inflation and commodity prices. Investors in commodities appear to have benefited from a hedge that no other asset class has been able to deliver this year.
Given historic monetary and fiscal loosening, we believe we are likely to see demand conditions remain strong and keep inflation elevated. It is difficult to anticipate supply-side shocks.
However, given that many supply chain disruptions are associated with restrictions in place from the Covid-era (such as the ease at which workers can travel across borders and port backlogs), we expect supply constraints to continue to push inflation higher.
Eventually, both of these will ease. On the demand side, central banks are already preparing to tighten monetary conditions. Supply chains may shorten and eventually goods will come to market more easily.
Does that mean the ‘commodity renaissance’ will end in the coming year? We don’t think so.
There are several themes that are likely to propel certain commodities over the coming decade. One key theme is an energy transition.
We believe an energy transition will take place, where we will move rapidly away from the consumption of hydrocarbons, which produce lots of greenhouse gas emissions, to renewable energy sources.
Driving this trend are the commitments to the Paris Agreement - a legally binding international treaty on climate change with a goal to limit global warming to well below 2 degrees, and preferably to 1.5 degrees Celsius, compared to pre-industrial levels.
All the materials that support renewable energy and technologies that enable the practical use of renewable energy such as batteries will be in greater demand.
An electrification of road transportation will augment this trend. In the commodity markets, this will be broadly favourable for base metals including copper, nickel, aluminium, zinc, and tin.