Cygnet Commodity Market Update | September 2022

Chart showing price changes in key commodities

Summer lull hides a weakening economy

Slower activity over the summer has brought a false calm to commodity markets, as underlying economic weakness persists and has soured further.

Most commodity prices are decreasing and returning to where they were last year. At the same time, underlying financial and economic indicators are pointing to an extended period of weakness in all major geographies. Governments are taking steps to soften the blow, but expectations that many countries will move into protracted recessions or worse are becoming stated forecasts.

Weak economics are undermining most commodities

In line with a weaker economic picture, many commodity prices and their forecasts have been easing. Even crude oil has fallen recently. This is not universal, however, as specific drivers are overcoming the economic drag for some, and natural gas in Europe remains persistently high.

Construction-focused commodities are seeing some of the most substantial falls. Expectations of construction growth have stepped down sharply in 2022, and the start of 2023 shows little prospect of a better picture. This is directly pulling down steel demand. Steel mills are shutting capacity to compensate, but prices are under pressure. 

On the other side, energy transition (ET) commodities are strong. Lithium and graphite – the two main commodities needed in electric batteries – have increased 250% and 45% year-on-year respectively. With electric vehicles demand surging and limited new mine capacity coming online, ET commodities will be well supported.

Of concern for the ET is satisfying copper demand. The additional copper needed for infrastructure, power grids and consumer electronics is expected to see annual copper production increase two- or three-fold over the coming 15-20 years. A momentous task, complicated by Chile, the largest source of copper ore, looking to evolve its mining code to better protect the environment, safeguard water reserves, and retain more of the profit.

The drag from inflation

After a sustained period of relatively benign levels, inflation in most economies is reaching its highest rate in decades. Businesses and consumers are reacting, but with no recent experience of inflation levels of 10%, 15% or higher, inflation is having an unsettling effect on confidence and, consequently, demand.

Consumer confidence in China and the United States has declined rapidly. In Europe, it has fallen 15 months in a row, before plateauing in August. At the same time, purchasing managers indices (PMIs) for construction and manufacturing are pointing to a rise in raw materials costs and a drop in future orders. However, slower output from these sectors is not clearly visible yet, implying weaker business sentiment will develop in the near-term months.

Fuel prices are a drag on sentiment and forecasts.

The main push for inflation comes from energy costs, specifically petroleum and natural gas, and food prices. 

The energy transition will help move demand away from fossil fuels and so bring down prices of oil and gas, but not meaningfully in the immediate future. High fuel prices are also driving up food production costs. Both fuel and food costs are related to the Ukraine-Russian conflict, but other factors, such as China’s ‘zero-tolerance’ policies to Covid-19 breakouts, are also contributing.

Now in its seventh month, the prospects of a protracted war in Ukraine are seeping into growth expectations. Even with the restart of limited agricultural produce shipments from Ukraine and Russia still being able to sell its oil, the loss of capacities and the disruptions to supply are significant. 

Brent prices might be coming down, which is reflected in lower prices at the pumps. However, energy is still responsible for strong inflationary pressures and, with winter approaching, casts a pall over sentiment and economic growth.

Inflation is yet to peak and will be an increasing drag on sentiment and economic growth. Inflation is mentioned explicitly as one of the contributory factors for the World Economic Forum (WEF) downgrading GDP growth for next year in most major markets in their latest update. The WEF is not alone in scaling back on its growth expectations.

Gloomy outlook for economic growth

The coming months will provide greater clarity on the depth of the economic slowdowns that will likely be experienced in 2023 and 2024. Forward indicators, consumer confidence and inflation, are all pointing to a negative picture. Action by central banks and governments could reduce the scale of the downturns but will almost certainly not be able to avoid them entirely.

For now, economic growth has been partly held up by savings accrued over 2020 and 2021 and supply tightness in the jobs markets, which is keeping unemployment low. Strong indications that consumer spending is tailing off or that unemployment rates are on the rise will be a warning that further reductions in economic forecasts can be expected. 

Overall, risks are overwhelmingly biased to the downside, with further economic downgrades highly likely.