Market Views: How much risk do supply chain disruptions pose to commodities?

Supply chains have been disrupted by surprise events such as the Colonial Pipeline hack and Suez Canal blockage. How do investors manage the risks posed to commodities?
Market Views: How much risk do supply chain disruptions pose to commodities?

A multitude of challenges in recent months, from a Suez Canal blockage to a cyberattack, have caused disruptions in global supply chains, halting the delivery of commodities such as energy and raw materials. But investors remain bullish on commodities, particularly for industrial metals, amid a low-interest rate environment and China's rapid advancements.

On Wednesday (May 12), Colonial Pipeline announced that it will take several days for the product delivery supply chain to return to normal after a cyberattack forced the company to close down operations and freeze IT systems for five days.

As the largest pipeline system for refined oil products in the US, Colonial Pipeline runs from Texas to New York and supplies about 45% of the East Coast’s motor fuel. Even though operations had restarted by Wednesday, fears of a gasoline shortage pushed national average prices above $3 – the highest in more than six years.

On the other side of the world, Egypt, also on Wednesday (May 12), announced plans to widen and deepen the southern part of the Suez Canal after the canal was blocked for six days by the grounding of container ship Ever Given in March.

The shutdown of the Colonial Pipeline in the US showed that threats can come from anywhere, Paul Jackson, global head of asset allocation research at Invesco, told AsianInvestor.

In addition, investors should also look out for heightened risks of short-term supply disruptions due to geopolitical conflicts in the Middles East, which could boost oil and gas prices, he added.

The S&P GSCI has risen more than 10% to 522.64 from 473, over the past month, as of May 13. It surged more than 90% in one year. ICE Brent Crude rose from $50 level at the beginning of the year to $68.7 on May 13, a 35% increase year-to-date.

Uncertainties due to Covid-19 also pose risks to supply chains, as countries such as India experience a surge in cases as even as vaccinations are taking place across the world.

With inflation on the way and demand for commodities set to accelerate, AsianInvestor invited experts to talk about what changes to expect and which commodity assets they favour.

Paul Jackson, global head of asset allocation research

We started the year positive on commodities with our attention focused on industrial and agricultural commodities. 

This was based on our expectation that 2021 would be a year of strong economic growth.  However, given the strength of prices in the meantime (with oil rising to the top of its normal historical range and copper approaching its historical peak, both in real terms), we feel that a lot of good news is already in the price. 

Allowing for the possibility that high prices will reduce demand and perhaps dampen economic growth, we have recently turned more neutral on our view. 

Among industrial commodities, we favour energy over industrial metals, based on the remaining upside to previous peaks.  

Keith Wade, chief economist & strategist

We are backing commodities and are conscious that the global economic recovery could be even sharper than we expect. Vaccine distribution and fiscal stimulus are driving the demand recovery.

Among the sectors, we have turned more positive on energy. The improvement in demand plus OPEC+ keeping supply steady should support the oil price.

On agriculture, we have become positive given robust demand for corn and soybean compared to last year. Global supply also remains under pressure from a low stock to use ratio.

Meanwhile, our positioning on industrial metals has remained positive. Despite weakening credit growth in China, demand in the rest of the world should recover strongly as activity normalises.

On precious metals, we continue to remain neutral. The improvement in the global economy has led to higher real yields, but ongoing central bank stimulus continues to underpin the low-interest rate environment.

George Cheveley, portfolio manager
Ninety One

For metals, prices have continued to rise.

Steel and iron ore prices have hit record highs globally and margins are at record levels, boosted by strong demand as well as steel production cuts announced in the Tangshan province in China to reduce pollution and emissions in order to meet targets for the new Five Year plan.

Looking forward to the second half of 2021, we believe stronger fiscal spending will lead to even tighter markets, particularly for metals used in construction such as copper, aluminium and steel. We do not see commodity prices, especially for many metals, returning to lower long-term averages, and thus margins for many producers can remain elevated.

After the destocking of 2019, supply disruptions, as a result of Covid-19, prevented inventories from building during 2020 even when demand collapsed in the second quarter. With demand recovering strongly, companies are struggling to restock and shortages for many commodities are appearing with prices rising sharply.

This crackdown on low added-value production in China represents a structural change as exports have historically kept global margins under pressure. This could affect aluminium markets where China has been a large exporter in recent years. 

Cheong Jin Yu, director, commodities

As one of the key commodities of modern society and the second largest after crude oil, iron ore is linked to industrial growth and urbanisation.

China’s rapid advancement has propelled the key steelmaking material into the A-list of commodities that are leading indicators of economic health. With 70% of all seaborne iron ore making its way to China, iron ore is attracting strong investor interest as a growth proxy in the world’s second-largest economy, and by extension the global one. Today, it has evolved into a financialised commodity traded as an economic bellwether and as Asia’s first truly global commodity.

In a low-interest rate environment fuelled by central bank easing and stimulus, iron ore ticks many boxes for asset managers, from China growth to demand for yield. This has seen iron ore included in the S&P GSCI Iron Ore and GSCI Industrial Metals & Iron Ore indices, providing investors with public, reliable, and transparent investment benchmarks.

And it has continued to break records alongside other commodities and proven as the best performing time and again. Funds would have consistently done well by taking advantage of the persistent backwardation of its forward curve, with the S&P GSCI Iron Ore Total Return Index outperforming others over the last few years. We expect iron ore to continue playing a critical role as global economies recover post-Covid.

Kelvin Fu, director
Gunung Capital

As active asset owners and investors in the building materials space that includes steel and cement, we see first hand that there is very strong pent up demand that had been suppressed by Covid-19 and huge infrastructure spending initiated by many governments to spur economic recovery.

What is less known is that the supply chain and logistics infrastructure is being bogged down due to enhanced Covid-19 measures where goods need to be inspected, the customs and loading staff face more friction in clearing goods.

We also see the emphasis on sustainability and investments to reduce carbon emissions will increase production costs and these green investments take a longer time to bear fruit, hence, we are likely to see this commodity supercycle being sustained.

Jason Liu, head of CIO office Asia Pacific
Deutsche Bank International Private Bank

We have turned overweight on commodities in our asset allocation earlier this year. We believe that commodity prices should remain supported in the coming quarters, backed by the strong global demand recovery, the supply chain disruptions, a relative weak US dollar and a shift for greener infrastructure and government energy mixes.

We think a broad basket of commodities should provide investment opportunities, including energy and industrial metals.

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