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Will the commodity boom last?

13:58, 20th May 2024

By Kathleen Brooks, research director at XTB.com

The gold and copper price both hit fresh record highs on Monday. The market is sensitive to these two metals because gold is considered an inflation hedge and a safe haven, and because copper is a metal that is linked to global growth. Copper is higher by 25% YTD, and gold is up by more than 17% so far this year, which is a stronger return than all global stock markets. The driver of commodity prices are diverse; however, commodity prices are rising sharply across the board. Below we will assess whether this can last, and what this means for financial markets.

Gold continues to shine in Q2

The gold price broke above $2,400 on Monday, ostensibly because of haven flows after the death of the Iranian Prime Minister in a helicopter crash and the fall out that could happen in the Middle East. However, haven flows are not the only reason the gold price has reached a record high, and the yellow metal has been rising steadily this year. The World Gold Council’s Q1 Gold Demand Trends Report, reported that demand for gold rose by 3% YoY in Q1 this year. The primary drivers of the gold price include central bank purchases, healthy demand from individual traders and more demand from Asian investors. Central bankers have been major buyers of gold so far this year, and they boosted their holdings of gold by 290 tonnes in Q1. This suggests that central banks are treating gold like a reserve currency to combat rising market risks and volatility. Interestingly, volatility as measured by the Vix index, Wall Street’s fear gauge, is at its lowest level since 2019, so there is not much volatility around.

Officials at the World Gold Council have attributed the surge in the gold price to 1, geopolitical tensions, which have led to sanctions on countries such as Russia and Iran, which make it difficult to trade the dollar and the euro, so gold is an alternative. 2, ongoing macroeconomic uncertainty. Gold’s inflation hedge status is attractive right now. Global growth remains strong, and there are signs that inflation may not quietly go away, as some expect. Central bankers seem determined to cut rates this year, but the ongoing inflation risks may attract some investors to gold. 3, Demand dynamics. Typically, buyers of gold in the East and West exhibit different behavioral trends towards gold. Eastern buyers have tended to wait until the gold price dips before buying, whereas investors in the West tend to feel more comfortable buying into a gold rally. However, this has been reversed, with demand growing in India and China last quarter, even as the price of gold rose sharply.

Another interesting fact about the gold price is that retail investors do not seem to be joining in the party. The World Gold Council reports that global gold ETF flows fell by 114 tonnes, with quarterly outflows from European and US ETFs in Q1. However, there were some inflows into Asian ETFs in the quarter and the latest data suggests that the outflows from US ETF flows may be slowing as we move into Q2, which is a trend to watch.

The World Gold Council expects demand for gold to remain robust in 2024 even though supply side dynamics remain firm. For example, gold mining production rose by 4% to 893 tonnes in Q1, a record high. Likewise, gold recycling also rose by 12% to 351 tonnes last quarter.

Another interesting angle to look at is how gold miners are performing. The NYSE gold miners index, as you can see in the chart below (orange line), is moving in the same direction as the gold price, but this chart has been normalized to show how the gold price and the gold miners index has moved together. As you can see, there is a gap in the performance, which suggests that the share prices of gold miners could play catch up at some point.

Chart 1: The gold price and gold miners 

Source: Bloomberg and XTB

Looking ahead, the prospect of more inflows into gold ETFs could add to upward pressure on the gold price. $2,500 per ounce is a key psychological level to watch for the yellow metal as it continues to make record highs.

Dr Copper’s record-breaking rally, but can it last?

Copper broke above the $10,700 per tonne mark at one stage on Monday, before pulling back slightly. The copper price has surged by several hundred dollars per tonne in just 5 days. A mixture of a supply weakness, speculative demand and traditional copper bulls have helped the copper price to rise by a quarter so far this year, overriding concerns about China’s faltering economy.

The fundamental story for copper is compelling: copper will be needed to help power all the extra electricity capacity that will be needed for the AI revolution and Electric Vehicles of the future. This is a multi-year infrastructure build-up across the world, and copper is the main ingredient.

A short squeeze in the US market in recent weeks has also added to upward pressure in the past month, alongside supply concerns. There are multiple drivers of a higher copper price, which makes it hard to pick a top in the current market.

However, commodity markets have a history of overshooting and then falling back quickly, so expect volatility in the copper price in the coming weeks and months, particularly if we see some weakness in global growth alongside any holes appearing in the AI narrative.

Looking ahead, some have argued that the copper price is looking over-extended because the copper- gold price ratio is stretched to the upside and is at its highest level since October. However, on a 5-year basis, this ratio does not look too stretched, and there could be further upside, especially if we get news from Nvidia, a major AI chip maker, later this week. Should copper be outperforming the gold price? One could argue that it is a more useful metal for the current economic environment, so we should not write copper off just yet.

Chart 2: Copper/ gold ratio

Source: Bloomberg and XTB

Commodity prices and the impact on interest rates

Overall, there are some who are worried that the Bloomberg Commodity Price Index, which is back at its highest level since September, could threaten the disinflation trend that we have witnessed around the world. While rising commodity prices can cause havoc with global inflation rates, we would argue that they are just one contribution to CPI indices. As commodity prices are rising, other aspects of inflation are falling, for example wages. While household energy bills are the largest weighting in the UK headline CPI basket, central bankers tend to prefer to look at the price of core inflation when setting policy, which strips out the effects of volatile commodity prices. Thus, for now, we believe that the surge in commodity prices does not derail prospects of rate cuts from the major central banks later this year. 

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