The CMCI Industrial Metals Index has extended its recent losses and is now around 18% below its March peak, amid investor worries that a slowing global economy will sap demand for commodities.
China’s zero-tolerance policy against COVID-19, which has prolonged and tightened lockdowns in Shanghai and increased mobility restrictions in Beijing, is adding to the economic headwinds. Trade data for April, released this week, marked the latest in a string of weak indicators.
While renewed bouts of global growth concerns could send industrial metal prices lower, we argue that such dips represent an opportunity for investors to add exposure. We see this as part of a broadly positive outlook for commodities and energy stocks.
China’s economy should rebound in the second half. While we recently lowered our forecast for GDP growth to 4.2% this year, we expect China’s economy to reach a trough this quarter and recover in the second half of the year. The lockdowns are unlikely to last, in our view, while Beijing has promised additional stimulus. Over the weekend, Premier Li Keqiang instructed all government departments and regions to prioritize measures aimed at helping businesses retain jobs. We also expect pent-up demand for industrial metals to emerge later this year, helping to make up for the current weakness.
Demand for industrial metals should continue to exceed supply. While we have trimmed our demand forecasts for copper, zinc, and lead, we have also scaled back our supply estimates. Producers' supply response to higher prices this year has so far been modest. As a result, we continue to see a tight market, with low inventories underpinning higher prices. Our bottom-up return estimates suggest a 20% upside for industrial metals over the next six to 12 months as we think the markets are underestimating the supply changes.
Oil prices should be supported by measures against Russian energy, while farm commodities are also in tight supply. Talks are continuing aimed at an EU-wide ban on Russian oil imports. French President Emmanuel Macron has said a deal could be struck this week despite opposition from Hungary. Stiffer sanctions against Russia contribute to an already tight oil market marked by low inventories and limited spare production capacity. Separately, grain production could also be disrupted by the war in Ukraine and by unfavorable weather in other producing countries. While the UN FAO's Food Price Index for April eased slightly from the record high in March, it remained nearly 30% higher than the same time last year.
For investors willing and able to withstand a likely volatility of more than 30%, we recommend staying long industrial metals. Our base metals of choice are aluminum, copper, and zinc, and consider volatility selling strategies as particularly attractive for the former two. More broadly, we expect another 10% move up in total return for broad commodity indexes over the next six months, and we see value in an active commodity strategy. Energy stocks should remain well bid as elevated oil, oil product, and natural gas prices contribute to strong earnings. More broadly, we continue to see commodities as an effective hedge against the war in Ukraine and rising prices.
Main contributor: Daisy Tseng
For more see the CIO report UBS House View: Positioning for inflation 28 April 2022.