Don’t count resources out

It has not been a strong year for commodities. Since peaking in June 2022, the Dow Jones Commodity Index – which tracks a basket of energy, metals and agricultural commodities futures – is down by almost 25%. Shares in many commodity producers have held up better, since today’s prices are still higher than those we saw in the past decade: oil majors can produce plenty of cash with crude at $70-$80 per barrel. But for those who expect inflation to head back to a steady 2% in the years ahead – in line with central banks’ targets – this looks like a helpful tailwind.

Yet commodity prices are always volatile and cyclical, even when they are trending upwards. Take oil: in 1999, it bottomed at around $10 per barrel (prompting The Economist’s infamous “Drowning in Oil” cover, suggesting that the price could still halve to $5). It reached an all-time high of $147 in 2008, on the eve of the financial crisis. Along the way, there were several swings as big as the one we’ve seen in the past 12 months.

Supply and demand

Some markets are unlikely to get back to their recent highs. European natural gas peaked at almost €350 per MWh in August and is now down to €33. Conditions have changed. The desperate stockpiling caused by the end of Russia supplies has passed. Storage is refilling fast. Prices will almost certainly rise again in the winter – but not to where they were last year. Meanwhile, on a long-term view, the amount of liquefied natural gas (LNG) terminals under construction will permanently change the structure of the market.

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But for most other commodities, there’s much more reason to think the decline is temporary. The continued reluctance to invest in new fossil fuel projects will create tighter supplies in future, unless we move to renewables much faster than expected. Meanwhile, the energy transition will require large amounts of metals such as copper. We don’t have the vast demand for commodities that China’s infrastructure spending created in the 2000s – and China’s long-term potential growth is now likely to be a lot weaker than many people expect. However, India’s population continues to grow – it probably passed China’s this month – and its middle class is expanding. The Indian economy remains much less investment-driven and we shouldn’t expect such a large supply shock but it should be a steady source of demand.

I am always reluctant to be structurally bullish on commodities: history shows us that most raw-material prices have declined in real terms over the very long term due to greater efficiency and substitution. Yet after a decade of under- investment, there’s solid reason to think we’re at the early stages of another up cycle. That’s likely to be another source of inflationary pressure over the medium term – and a good reason to hold a few oil firms and miners as a hedge.