image-ad
Subscribe Now Join thousands of other Vintage Value readers today!

The Impact of the Pandemic on Commodities Markets

April 20 brought a historic rout in the oil market with West Texas Intermediate (WTI) futures plummeting to over negative $38 a barrel.

Market commentators predicted a deflationary wave that would complicate recovery and possibly diminish the influence of oil-rich Russia and Saudi Arabia.

This is just a glimpse of how the coronavirus pandemic is upending markets, creating a new slate of winners and losers, and presenting opportunities for investors and traders.

What Is Happening to the Economy?

At the beginning of the year, the International Monetary Fund projected global economic growth at about 3.3%. This number was lower than expected.

No one should be surprised that such predictions are trending downward fast. The spread of the coronavirus pandemic delivered severe supply and demand shocks.

Layoffs and Increasing Unemployment

In the U.S., business and consumer lockdowns designed to help slow the spread of COVID-19 have led to at least 23 million people losing their jobs. That means the number of jobs gained since the 2008 recession have been wiped out.

Business Insider notes that due to application difficulties and delays in the rollout of the Pandemic Unemployment Assistance, the number may be higher.

U.S. unemployment is currently at 14.7% a rate not seen since the Great Depression. However, some have speculated the true number is higher, since some may not have been able to successfully complete the application process.

Many businesses may not reopen if the economic shutdown is extended, especially smaller entities that were already operating on razor-thin margins before the pandemic.

The economic toll of the pandemic is severe. Some states are preparing to reopen, despite recommendations from health officials to delay.

Consumers Hoard Cash, Pay Down Debt

The savings rate of Americans increased to 13% in March —  a level not seen since 1981. Americans now have over $2 trillion in savings. And they’re paying down credit card debt at an accelerated pace.

The impact of this frugality on the economy as a whole is yet to be seen.

A Closer Look at Commodities

When discussing market winners and losers in commodities, it’s important to remember that some YTD losers have surged dramatically in the current quarter.

Oil

Russia and Saudi Arabia engaged in an oil price war and production hikes that resulted in prices dropping significantly. Though the two countries agreed on a truce at the beginning of April, the effects of COVID-19 resulted in a massive demand slump.

A glut of oil ensued and storage began filling up to capacity quickly. By mid-April, the US was considering paying drillers to leave the oil in the ground to help mitigate the price decline. Futures traders raced to exit May contracts in order to avoid taking delivery. WTI plummeted to more than negative $38/barrel.

Since then, Russia, Saudi Arabia, and US shale producers have agreed to steep production cuts and that has fueled a partial rebound in futures.

Consider, that YTD:

  • Crude oil is down -45.2%
  • Gasoline is down -38.5%
  • S&P 500 Energy is down -35.3%

But the story in Q2 (as measured on May 21, 2020) is significantly different:

  • Crude oil is up +63.5%
  • Gasoline is up +82.1%
  • S&P 500 Energy is up +32.2%

Some 23 U.S. states are re-opening, leading to speculations on increased demand for oil.

Goldman Sachs currently expects Brent Crude to stay in the $30 range in Q3 and to hit $40 in Q4.

The future remains uncertain for highly leveraged US shale producers. Some of these companies have a long-term debt/equity ratio as high as 90+%. (Source: MarketWatch / FactSet). Keep an eye on banks with heavy exposure to this overleveraged sector and factor in the individual companies’ recent track records regarding raising capital.

Investors may want to research oil and gas companies with a low debt-to-equity ratio.

The US shale industry will have fewer players in the future, and those players will have healthier balance sheets. Expect the industry as a whole to experience lower growth.

Gold as a Safe Haven

Gold prices are tied to the value of the US dollar, the currency in which the metal is most commonly traded, as well as governmental and central banking demand.

Uncertain economic conditions typically lead to increasing gold prices as investors move from riskier assets to gold. It has long been seen, along with US Treasuries, as a hedge against inflation.

“The Fed Can’t Print Gold”

In mid-May Bloomberg reported that hedge fund titans like Paul Singer, Crispin Odey, and David Einhorn and large asset managers Blackrock Inc. and Newton Investment Management are bullish on gold.

The yellow metal is seen as a hedge against inflation that is expected in the wake of trillions in stimulus and bailout money being “printed.”

Bloomberg quoted from a letter that Singer’s Elliott Management Corp. sent to investors. He cited “fanatical debasement of money by all of the world’s central banks” along with mining lockdowns and low interest rates. These will result in gold attaining “literally multiples of its current price” Singer wrote.

In late April, in a report titled “The Fed Can’t Print Gold,” Bank of America predicted gold may reach $3,000 in 18 months.

At the time of this writing, gold is up over 15% YTD. (Source: Wall St. Journal tracking of the continuous front-month futures contract.)

Still in a Bear Super-Cycle?

In remarks made to MarketsInsider, analyst John LaForge advised caution: “Gold is a commodity, and commodities run together like a family in long super-cycles (bull and bear). Right now, commodities remain in a bear super-cycle that began in 2011. I believe that it could still be a few years until commodities enter their new bull super-cycle.” (LaForge is head of real asset strategy at Wells Fargo Investment Institute.)

Silver, Platinum Rebound in Q2

While silver is up only 1% YTD it has rebounded from the initial market meltdown. Platinum has also rebounded but the South African platinum mining industry is reeling from shutdowns.

  • Silver is up this quarter +27.2%
  • Platinum is up this quarter +28.4%

Orange Juice Soars

Orange juice YTD is up over 28%, with consumers seeking to boost their immune systems and supply chain disruptions squeezing deliveries. Adverse weather in Brazil has also affected the orange crop there and impacted prices.

Reports indicate consumers are favoring frozen orange juice in particular because it can be stored long-term and can allow for fewer trips to the grocery store.

In terms of YTD market winners, orange juice has now surpassed  20+ year US Treasurys (+21.2%) and is ahead of gold.

Uranium: A Surprise Winner

By mid-May uranium, under a supply squeeze, was on a tear, up a third over the previous 6 weeks. Canada’s Fission Uranium Corp. (OTCMKTS: FCUUF)  climbed 78%.

Investors and traders can get exposure to uranium in a number of ways. You can trade uranium futures (UX) on NYMEX or uranium 308 futures (UxC) on CME. But more commonly investors get exposure via ETFs and stocks, such as:

If you are day trading sure to use technical analysis to check on momentum and price direction before buying or selling. Investors should also take care to conduct analysis before buying uranium.

Continued Uncertainty

Governmental policies change often as scientists learn more about COVID-19. Some of the biggest factors impacting commodity prices are whether the economy stays shut down and for how long.

The twin supply and demand shocks have been global in scale and unprecedented. Consumers are hoarding cash amid record unemployment: will this lead to a deflationary spiral?

Will some metropolitan regions have to shut down again after re-opening? Will a purported “second wave” of the coronavirus lead to new lockdowns in the fall or winter?

Some monetary policy analysts believe we’re looking at a period of deflation followed by significant inflation. If that’s the case, one could expect commodities as a broad class to enter bull market territory in the coming years.

And while some hedge fund leaders are bullish on gold, consider: similar positions were taken for the same reasons in the wake of the Great Recession’s QE (quantitative easing) programs, and yet anticipated inflation levels did not occur. Investors need to decide: Is this time different?

Note: YTD and Q2 commodities and US Treasuries price changes cited here are based on The Wall St. Journal tracking of continuous front-month futures contracts as measured on May 21, 2020.