Commodities spent much of the past decade in the doldrums, as the excitement about “supercycles” faded into a familiar boom-and-bust. In the aftermath of the pandemic, that’s changed: investors are getting far more involved in metals markets. Meanwhile, long-term commodity bulls are getting a favourable hearing as they set out a case for rising demand and tight supply caused by the electrification of the energy system.
Bulls can get carried away by this in the short term: copper is actually down by $2,000 per tonne since Jeff Currie was interviewed by Bloomberg. The dynamics look very complex right now. Chinese end-user demand is soft due to the weak economy (especially in real estate – construction uses a lot of copper). Yet Chinese copper stocks in warehouses have been building steadily and are at multi-year highs (that could reflect traders building positions in anticipation of a big government stimulus programme, which has so far not been forthcoming). That’s a large amount of metal that might be dumped back on global markets.
Miners have announced various production cuts and other supply disruptions. Meanwhile, smelters – who turn ore into refined copper – have added large amounts of new capacity in China and elsewhere, to the point where Chinese smelters have tried to coordinate production cuts because too many smelters competing for tight ore supplies has driven them into the red. Put all that together and it sounds a bit like a recipe for very volatile prices in the near term, rather than a one way bet upwards. Still, over the longer term, there is a strong argument that we have not invested enough in supply to meet future demand.
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What to consider when investing in commodities
However, it’s also worth thinking about how short-term price dynamics can affect your returns when you are looking for the right entry point. If you are trading commodities, you’re typically using either futures or an exchange-traded fund (ETF). The latter will in turn usually track an index of commodity futures. There are a few ETFs that hold physical commodities, but it’s a minority – mostly precious metals.
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To keep a futures-based trade open for a while means rolling the position over into a later month as each contract gets close to expiry. If you are trading futures, you must do this directly. With an ETF, the index mimics this process. Either way, your returns are affected by the “roll yield” or “roll return” – the difference between the price of the contract you sell and the contract you buy. When near-term futures are higher than later ones (backwardation), you gain on the roll yield. When they are lower (contango), you lose.
Unfortunately, copper is in contango on the London Metal Exchange at present, as are many other metals. This indicates immediate needs are fairly well supplied (users aren’t rushing to secure supply). Note that this says little about the outlook – futures prices are not a reliable indicator of where cash prices will go in future! However, the negative roll yield might be a drag on returns if you’re buying commodity ETFs now.
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