- Q4 winners - Lumber leads the way higher.
- Q4 losers - Freight rates, coal, and natural gas prices moved lower.
- 2021 winners - Many double-digit percentage gains.
- 2021 losers - Precious metals dominate the loss column.
- Three reasons the commodity rally will continue in 2022. GSG moves higher or lower with commodity prices.
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Economist Mohamed El-Erian recently called "transitory" the Fed's worst call-in history. The global pandemic pushed commodity prices to multi-year lows in 2020, setting the stage for a spectacular comeback and rallies in the year that ended on December 31, 2021.
The central bank liquidity and government stimulus programs worldwide that stabilized the global economy lit a bullish fire in the commodities asset class. The US Fed spent months calling inflationary pressures "transitory," blaming the economic condition on pandemic-related supply chain bottlenecks. At the December FOMC meeting, the world's leading central bank finally capitulated and retired the term, acknowledging inflation is an increasing structural issue that requires a more hawkish approach to monetary policy. Commodity prices spent 2021 warning the central bank. The Fed finally had an epiphany in December after the latest CPI data.
Most commodity prices rose in 2021 and continued to exhibit bullish trends at the end of the year. The iShares S&P GSCI Commodity-Indexed Trust (NYSEARCA:GSG) follows commodity prices higher or lower.
Thirty out of forty-one commodity markets posted gains in the fourth quarter of 2021:
The chart shows the wild volatility in the lumber futures arena in 2021. Before 2017, the wood futures market never traded above the 1993, $493.50 per 1,000 board feet all-time high.
Meanwhile, lumber started at a high price at the end of 2020 when it settled at $873.10. The price exploded to a high of $1,711.20, the new record peak in March 2021, before imploding and falling to under one-third that price in August when it found a bottom at $488. By the end of 2021, the price was back over $1,100, with the nearby futures contract settling at $1,147.90 on December 31, 2021.
Lumber is a highly illiquid market with only 2,344 contracts of open interest. By contrast, open interest in liquid commodity markets are at far higher levels as of the end of 2021:
- NYMEX crude oil - 1,866,914 contracts
- COMEX gold - 512,591 contracts
- COMEX copper - 181,604 contracts
- CBOT corn - 1,512,771 contracts
- ICE frozen concentrated orange juice - 10,701 contracts
Even the illiquid FCOJ futures market had over four times the open interest as the lumber market. Illiquidity magnifies price action during rallies and corrections as bids and offers tend to evaporate during significant price moves. The lack of liquidity exacerbated lumber's price action and led to extremes. However, lumber is a bellwether industrial commodity that tells us about the demand for new homes, supply chain bottlenecks, and infrastructure requirements. Lumber's move higher at the end of 2021 showed that inflationary pressures remain a clear and present danger for 2022.
Meanwhile, the second and fourth leading gainers in Q4, soybean meal and oats, are critical inputs in foods and animal feed, and rising input costs are additional inflationary signals. Ethanol's price gained over 18% in Q4 as US energy policy favors alternative and renewable fuels over traditional hydrocarbons. Meanwhile, corn is the primary ingredient in Us ethanol production, and the coarse grain rose by over 10.50% in Q4.
All commodities that posted double-digit percentage gains in Q4 were industrial commodities or agricultural products, which is another sign that inflation remains rampant.
Winners outnumbered losers by nearly 3:1 in Q4 as only eleven commodities suffered losses.
The Baltic Dry Index suffered the most substantial decline at over 55%, as it closed at 2,217. However, the BDI reached a high of 5,647 earlier in 2021 and was still 62.3% higher in 2021. The coal futures price may have dropped by over 46% in Q4, but the price reached a record peak in October before imploding, and coal was still over 70% in 2021. Natural gas had experienced wild volatility since June 2020, when the price dropped to the lowest level since 1995. The quarter-of-a-century low took the energy commodity to $1.432 per MMBTU.
The chart shows that natural gas moved from a twenty-five-year low in late June 2020 to 2.70 cents shy of the highest price since February 2014, when it reached $6.466 per MMBtu in October 2021. Natural gas shortages in Europe and Asia and fears over the uncertainty of the peak US demand season lifted prices as stockpiles were below last year's level and the five-year average going into the winter withdrawal season. Demand for US LNG has been booming over the past years.
Meanwhile, Russian gas flows into Europe caused foreign prices to decline, and warm US temperatures turned the explosive rally into an implosive decline in November and December, sending prices to a low of $3.36 in late December. Natural gas may have declined 36.42% in Q4, but the price was still 46.91% higher in 2021. Almost all of the other commodities that fell in Q4, including hogs, sugar, soybean oil, aluminum, Brent crude oil, and heating oil futures, had reached multi-year highs at some point in 2021.
2021 was an extremely bullish year for the commodities asset class, with winners outnumbering losers by more than 4:1. Thirty-three commodities posted gains in 2021 compared to only eight losers.
Some of the leading gainers in 2021 were highly illiquid commodities, including LME Tin, oats, and coal. The illiquidity exacerbated price moves to the upside. Meanwhile, a frost in Brazil and pandemic-inspired supply chain bottlenecks lifted coffee's price by over 70%. However, gains in energy prices were significant, with oil and oil products rising over 50% on a year-on-year basis, stoking inflationary flames. The US was the world's leading energy producer over the past years, but the Biden administration's initiatives to address climate change caused production to decline. Lower US fossil fuel output increases OPEC's control of prices in the oil market. When it comes to coal, China and India remain substantial consumers, and supplies have declined as the leading producers move away from hydrocarbons. US energy policy lit a bullish fuse under traditional energy commodities in 2021, with ramifications for other raw materials as energy is a critical production input for food, metals, and minerals. Moreover, the rising demand for battery metals for EVs, wind turbines, and other clean energy initiatives, lifted base metals prices in 2021. Energy was the top sector in 2021 with a 54.13% gain, and base metals were second, gaining 38.09% from the December 2020 closing level. Soft commodities moved 31.57% higher in 2021, and grains were up 29.71% for the year. Animal protein prices gained 19.16% as five of the six commodity sectors posted double-digit percentage gains.
The eight lonely commodities that posted losses in 2021 included:
Iron ore dropped over 24% in 2021, but the price was nearly 73% higher in 2020. Palladium was the second-leading loser for the year, but the price rallied to a record high at over $3,000 per ounce in May. A semiconductor shortage weighed on palladium, platinum, and rhodium prices in 2021 as they are critical metals in catalytic converters. As automobiles did not roll off assembly lines, the demand for platinum group metals declined. Silver fell over 11.5% in 2021, but the price reached the highest level since 2013 in early February. Silver did not trade outside the 2020 range, making 2021 an inside year for the volatile and speculative precious metal. Precious metals fell 11.91% in 2021 after gaining 27.85% in 2020. Gold declined by 3.51% in 2021, but the price reached an all-time high of $2063 in August 2020, making it the first commodity to soar to a record level. Gold spent the second half of 2021 consolidating around the $1800 per ounce level and closed just above the technical pivot point on December 31.
Three reasons the commodity rally will continue in 2022 - GSG moves higher or lower with commodity prices
As we head into 2022, at least three factors will likely support higher lows and higher highs in the commodities asset class:
- At the December FOMC meeting, the US central bank forecast a 0.90% Fed Funds rate in 2022 and 1.60% in 2023. Even if inflation recedes, short-term interest rates will remain in negative territory, which will continue to fuel inflation.
- US energy policy to address climate change has handed crude oil's pricing power back to OPEC and Russia. The cartel would rather sell one barrel of oil at $100 than two at $40. Moreover, after years of suffering from low prices because of rising US shale output, the policy shift allows OPEC to squeeze higher prices from US and world consumers. Higher traditional energy prices put upside pressure on all commodities.
- The dollar index rallied by 1.44% in Q4 and 6.34% in 2021. A rising dollar tends to be a bearish factor for raw material prices. Bonds are trending lower, which also tends to put pressure on commodities. The index is a mirage when it comes to the dollar as it measures the US foreign exchange instrument against other fiat reserve currencies. The bullish price action in stocks, real estate, cryptocurrencies, and commodities is a sign that all fiat currencies are losing value, including the dollar. The US currency may be the strongest, but it is the best horse in the glue factory as all legal tender is losing purchasing power. Falling bond prices and higher interest rates have a long way to go to stem inflationary pressures, which continue to rise from the highest levels in nearly four decades at the end of 2021.
I expect a continuation of the bullish relay race in commodities in 2022 and beyond. The US debt is at almost $30 trillion. Each 25-basis point hike in the Fed Funds rate will cost the US another $75 billion in annual debt servicing costs. Labor costs, land values and rents, input costs, and other commodity input prices have increased substantially. Commodity prices must rise to keep pace, or producers will cut back on output. Inflation creates a vicious cycle of increasing costs. Energy is at the heart of the problem, but the Biden administration shows no signs of increasing US fossil fuel output. In Q3 and Q4, the administration twice asked OPEC+ to increase production. The cartel refused. In November, the administration released fifty million barrels of crude oil from the US strategic petroleum reserve, amounting to only three days of US requirements. Meanwhile, Chinese crude oil imports rose in November, the month of the SPR release, meaning the barrels headed east to meet the Chinese demand.
The fund summary for the iShares S&P GSCI Commodity-Indexed Trust (GSG) states:
At the end of 2021, GSG had $1.432 billion in assets under management. The ETF trades an average of over 1.5 million shares each day and charges a 0.75% management fee.
GSG moved from $12.33 on December 31, 2020, to $17.11 per share on December 31, 2021, a 38.77% gain. The composite of 29 commodities that trade on futures exchanges in the US and UK moved 26.79% higher in 2021. Increases in energy prices caused GSG to outperform the commodities asset class in 2021. I expect commodities and GSG to continue on a bullish path in 2022.
The Hecht Commodity Report is one of the most comprehensive commodities reports available today from a top-ranked author in commodities, forex, and precious metals. My weekly report covers the market movements of over 20 different commodities and provides bullish, bearish, and neutral calls; directional trading recommendations, and actionable ideas for traders.
This article was written by
Andrew Hecht is a 35-year Wall Street veteran covering commodities and precious metals.He runs the investing group The Hecht Commodity Report, one of the most comprehensive commodities services available. It covers the market movements of 20 different commodities and provides bullish, bearish and neutral calls; directional trading recommendations, and actionable ideas for traders. Learn more.
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