Why the commodity rally should run out of steam

Thought of the day

by Chief Investment Office 12 Jan 2018

Commodities are on a roll. Brent crude hit a three-year high above USD 70/bbl on 11 January, and the UBS Bloomberg CMCI Total Return Index (CMCI) was up 8.1% last year. Chinese commodity demand continues to hit records: it recently passed the US as the world’s largest importer of oil, averaging 8.43m barrels a day in 2017, and its copper ore and concentrate imports also rose to a record 17.5m tonnes in 2017.

Supported by improving economic growth and constrained supply, broad commodity indexes are likely to continue their ascent at the start of 2018. But we think the rally will run out of steam:

  • The pace of growth is more important for commodity returns than its level. We expect global economic growth to stop accelerating in 2H18. Our analysis of monthly CMCI returns since 1998 shows that once growth slows, even from above-trend levels, commodity returns start to reverse or slip below historical averages.
  • In our view, China will be the key driver of fading growth momentum, which is likely to accentuate the negative impact given its position as the largest importer of a number of commodities.
  • Increased supply in response to higher energy prices, and also later this year in base metals, is likely to weigh on returns. In energy, global oil supply should rise by 1.9mbpd and exceed our expected demand growth for this year, shifting the oil market from a deficit into balance.

So, as the year progresses, we think the market could surrender its initial gains and turn negative. We expect the asset class to deliver low- to mid-single-digit losses, making exposure to broad commodity indexes unattractive over a 6–12-month horizon.

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