Commodities are forging a record-setting run of gains that straddles the end of 2017 and the start of the New Year as crude oil notches multiyear highs and investors bet that booming global manufacturing output will help to sustain rising demand for raw materials.
The Bloomberg Commodity Spot Index posted an unprecedented 14 days of gains to late Wednesday, closing at the highest since February. The index is poised for further gains as metals and oil climb higher, supported by supply disruptions, a weaker dollar and improving demand.
Palladium, a metal used in car exhaust systems, is approaching an all-time high. Commodities eked out a second annual gain last year and heading into 2018, banks including Goldman Sachs Group Inc. are optimistic there will be further advances. Last month, the firm reiterated its 12-month overweight recommendation.
The index has rebounded 12% since mid-June. In recent days, the cold snap in the US, which helped to boost wheat as well as natural gas, is also helping to lift the index. Still, prices remain well below the highs from 2008. Copper, a bellwether for global manufacturing, climbed 1% after US factory output data beat expectations.
China also imposed heavy curbs on scrap imports, leaving buyers there more reliant on mined output, which analysts see tightening in the months ahead.
Record readings for manufacturing in Europe earlier in the week are also adding to the bullish mood. Chinese factories are likely to boost output to meet rising overseas demand, adding momentum to the spell of synchronized growth across major global economies in recent months.
"European and US PMIs have been very strong, and when you have manufacturing growing as strongly as it is in the world's two largest economies, it's going to have a pull on Chinese exports into these developed regions," Max Layton, the EMEA head of commodities research at Citigroup Inc., said.
"Rarely has the outlook for a New Year been as encouraging as it is today," said Holger Schmieding, chief economist at Berenberg Bank in London.
A Conundrum
With factories around the world humming, demand for raw materials is fast increasing. The BCSI, tracking the price of 22 raw materials, jumped to its highest since December 2014 on Thursday.
For the global economy, the pickup in commodities poses a conundrum. It could show how years of ultra-lax monetary policies have finally boosted activity and may even be enough to revive long-dormant inflationary pressures. The risk is inflation reemerges faster than central banks expect, forcing them to raise interest rates more aggressively than they now plan or investors anticipate.
According to a September study by the International Monetary Fund, a 10% gain in the price of oil increases, on average, domestic inflation by about 0.4 percentage points.
Strong Demand and Disruptions
After years of worrying about deflationary risks, investors are starting to think in the other direction. How much fallout there is on the economy ultimately depends on whether the rise in commodity prices is driven by increased demand or a decline in supply.
Beyond stronger demand, commodities prices are though also benefiting from less-friendly supply constraints, notably the reduction in oil supply orchestrated by Saudi Arabia and Russia. In copper, investors worry that wage negotiations in Chile, the world’s largest producer of the red metal, could disrupt mining activity. And freezing weather in the US, the world’s top producer of agricultural commodities, is helping to increase the price of wheat and other grains.
On the flip side, the rally could sow the seeds of its own destruction as producers such as shale oil companies bringing extra supplies to cash-in higher prices.
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