Commodities’ demand-supply balance out of whack due to the virus

When the coronavirus first hit China, initial concerns centered around its impact on the supply of commodities. But the virus went on to roil global economies as they locked down to limit its spread and impact. For all commodities, the disaster then snowballed into the biggest demand collapse in history, observes Roland Morris, Portfolio Manager and Strategist for the Commodity Index Strategy team at VanEck, in an interview.

“All commodities fell roughly 20-25% in the first quarter,” says Morris. “It was all really related to fears around how long economies are going to be shut down and how severely demand will be impacted.”

Crude oil

Morris said it was a historic mismatch of demand and supply “of anything I’ve ever seen in commodities.”

He observed that with storage tapped out, the crude market was driven into a “super contango” premium of almost 50% one year out.

“We'd never seen the curve that steep in contango,” observes Morris. “We saw it briefly in 2008.”

According to Morris, the phenomenon showed up how prices in the oil market got “completely disjointed, and the pressure on the front of the curve was so pronounced relative to the back end.”

The situation is still murky because there is no certainty of when demand for oil will return.

Gold

Morris observed that gold benefited from its “safe haven asset” status and central banks’ stimulus measures. The latter could lead to inflationary pressures.

He also pointed to the sizable premium that gold futures were trading over the spot price. This was likely due to difficulties in actually moving physical gold to effect deliveries to the exchange.

Morris said such a premium was rare. “It has happened in brief periods, but that is something interesting, and I'm not sure anybody's entirely sure why that has happened.”

Industrial metals

Morris warned of the scale at which production was being shut down due to the virus lockdowns. He observed that nearly a third of the current production of an important commodity like copper was shut down.

“Over time you'll see production shut down everywhere, including in energy, just because of the price,” he said.

He said this could eventually lead to a destruction of supply and this could severely impact such commodities when demand comes back.

“So, the virus is having an effect on both sides. Clearly, now we're more worried about demand. But as we go forward with some of these mines being shut for health concerns, you're going to have concerns about actual supply, so there's two sides to the forces here.”