HSBC: The "supply-side big story" of commodities

Since March this year, various bulk commodity prices such as gold, copper, crude oil, and cocoa have started a "crazy surge" mode.

International gold has risen from $2050 per ounce to nearly $2200; as a global economic barometer, London copper prices have surpassed $9000 per ton, reaching a new high in nearly a year; crude oil prices have also continued to rise, with ICE oil prices breaking through $83 per barrel.

The most active cocoa futures for delivery in May on the U.S. ICE Futures Exchange approached $8400 per ton at one point this week, with a year-to-date increase of over 100%. Other major agricultural products that have risen by over 10% this year include beef, lean pork, orange juice, and sugar.

A team led by HSBC economist Paul Bloxham pointed out in a recent report that the main reason for the continued high prices of bulk commodities is supply constraints. The bulk commodity market is in a state of "super squeeze" on the supply side, driven not by demand-driven "super cycles," but by three key structural factors driving the "super squeeze": climate change, energy transition, and geopolitics.

HSBC stated in the report that bulk commodity supply will still be in a "super squeeze" state in 2024. From a long-term and structural perspective, the impact of energy transition and climate change still has a long way to go, while geopolitical uncertainties are high. It is expected that bulk commodity prices will continue to rise by 4% in 2024 and fall by 4% in 2025.

Bulk commodity prices remain at historical highs driven by supply

HSBC pointed out in the report that bulk commodity prices have remained stable overall since mid-2023, staying at high levels relative to historical levels. The International Monetary Fund's bulk commodity price index has fallen 34% from its historical high in mid-2022, but is still 40% higher than the average level from 2015 to 2019 in nominal terms:

Major bulk commodity prices are far above pre-pandemic levels. For example, Brent crude oil is priced at $82 per barrel, copper exceeds $8500 per ton, iron ore prices are above $100 per ton, and gold prices recently hit a historical high, approaching $2200 per ounce.

HSBC believes that strong demand is partly the reason for the high bulk commodity prices, but the key factor still lies in the "super squeeze" state on the supply side, driven by three key structural factors: climate change, energy transition, and geopolitics:

Despite global economic slowdown, demand for bulk commodities remains high. For China, infrastructure and manufacturing investment support demand for metals. Energy transition is boosting demand, with China increasing demand for "green" products such as solar, wind power equipment, and electric vehicles. Investments in energy transition in countries like the U.S., Europe, and Japan are also supported by substantial government subsidies and are playing a role We believe that the main reason for the continuous high prices of commodities is the ongoing supply constraints. As we have mentioned before, the commodity market is in a state of "super squeeze" on the supply side, rather than a "super cycle" being driven by demand.

Supply-side "super squeeze" continues, commodities will continue to rise

HSBC points out that while supply constraints do not exist for every commodity, from a long-term and structural perspective, the impact of energy transition and climate change will continue, and the "super squeeze" on the supply side is not over:

Although lithium and nickel supply will increase in 2023, as well as the increase in US shale oil supply, we believe this is an exception. Actions by OPEC+ and other geopolitical factors continue to limit crude oil supply, and for metals, new production capacity remains limited. In addition, while there has been some improvement in food supply, geopolitical and climate-related issues have pushed up the prices of many "fine foods."

In addition to climate change and energy transition, HSBC emphasizes the high geopolitical risks in 2024, with a large number of elections coming in 2024, especially the US presidential election, leading to the risk of supply disruptions in commodities:

We believe that many countries are seeking to localize commodity supply chains for geopolitical reasons, leading to an increasing degree of market fragmentation and upward pressure on commodity prices.

HSBC believes that geopolitical uncertainty has played a key role in driving oil and natural gas prices. Over the past six months, the Israel-Palestine conflict has become a major factor in oil price movements. Additionally, the extension of OPEC+ oil supply cuts has also supported oil prices. For natural gas, geopolitical conflicts in Europe have kept supply risks present:

Despite the growth in US shale oil production in 2023, escalating geopolitical risks and continued supply constraints by OPEC+ remain key factors in keeping oil prices high. The HSBC oil and gas team expects that for most of 2024, the global oil market will remain significantly undersupplied, mainly due to OPEC+ restrictions on crude oil supply.

Oil prices are expected to remain in the range of $70-80 per barrel in 2024, with geopolitical risks providing support for prices around $70 per barrel in the medium term.

HSBC points out that gold has recently surged to historic highs, partly due to the prospect of Fed rate cuts combined with a weak US dollar, geopolitical risks, and uncertainty in financial markets, driving gold prices to historic highs HSBC emphasizes that the price of gold is easily affected by geopolitical risks, and gold, as a "safe haven" asset, may strengthen in key election years. However, the US dollar is not expected to remain weak in 2024, which could bring downward pressure on gold prices. It is anticipated that the gold price will fall to $1947 per ounce in 2024:

The trend of the US dollar in 2024 will have a significant impact on the direction of gold. Concerns about the Fed raising interest rates at the end of 2023 have weakened, leading to a decline in the US dollar. While expectations of a rate cut may support gold price increases, a weak US dollar is another supporting factor. However, we believe that the weakness of the US dollar will not persist until the end of 2024, which could have a significant impact on gold and may bring pressure on gold prices.

Although geopolitical factors may not be the decisive factor affecting gold, their importance has increased significantly in recent years. Geopolitical risks intensifying in 2024 will undoubtedly impact gold. It is expected that there will be 75 elections, and if geopolitical and economic uncertainties escalate, it may trigger buying of "safe haven" gold.

HSBC believes that metal prices are generally influenced by the energy transition in various countries, and key metals such as copper and aluminum will gradually enter a supply-demand gap phase. It is expected that copper prices will rise to $8818 and aluminum prices will rise to $2195 in 2024:

Metal prices largely reflect the impact of global green transformation, with key commodities like iron ore, copper, and aluminum being boosted by the energy transition. Mining investments are hindered by uncertainties, including concerns about geopolitical changes and their potential impact on policies.

However, the industry continues to face significant upside risks from supply disruptions. Risks/returns for most metals are skewed towards the upside due to sustained supply tightness caused by inadequate investments. Considering the current and future supply constraints, a significant demand surge could lead to supply shortages in the metal market, driving up metal prices.

For copper, recent production disruptions at Cobre Panama and production cuts by major producers will make the market tighter in the medium term than previously forecasted. Underinvestment in new mines, with capital expenditures far below the peak of 2012/super cycle, may require further investments to increase the overall industry capacity.

At the same time, HSBC believes that geopolitical and climate factors have played an important role in driving agricultural products, including a range of fine foods such as cocoa, coffee, orange juice, and olive oil, to see significant price increases:

For most of 2023, better-than-expected supplies have been a key factor in keeping agricultural prices low, especially for corn and wheat. However, constrained supplies may still be supporting prices. This is particularly evident in commodities like rice. Export bans on Indian rice and the El Niño phenomenon could tighten global rice supplies and push prices higher

"Fine foods" and beverage products are more sensitive to weather conditions. Among the 42 commodities tracked in the report, three commodities experienced significant year-on-year price increases in January 2024 - cocoa beans, orange juice, and coffee.

The El Niño phenomenon has caused extremely humid weather in West Africa, leading to fungal diseases in cocoa crops, hindering the production and harvest of cocoa beans. On the other hand, due to increased pressure on fertilizer costs, producers have reduced the use of fertilizers, increasing the damage to cocoa trees from pests and diseases