How to invest in commodities

Horizons article
May 21, 2024

Government intervention in industries has become a critical theme for financial markets, as we discussed in a previous edition of the Dasym Horizons. Our earlier focus was on the impact of policies promoting local production (or autarky). These policies, which aim to boost production in specific sectors, have brought another segment of the financial markets into government focus: commodities essential for industrial objectives. This raises the question of how government policies might reshape commodity markets in the coming years.

The S&P GSCI serves as a benchmark for commodity markets. As of April 2024, its composition is primarily energy (61%), followed by agriculture (18%), industrial metals (11%), livestock (6%), and precious metals (4%). There are significant differences among these commodities. Metals, for instance, are highly concentrated geographically in specific countries such as China (copper, lithium), Indonesia (nickel), Chile (copper), Australia (iron, bauxite, lithium), and the Democratic Republic of Congo (cobalt). In contrast, energy and food are more evenly distributed across various regions.

However, the most significant difference between these commodities is the impact of government policies. Unlike energy and food, metals have experienced a notable increase in demand in recent years due to various policy-driven initiatives. Key examples include policies promoting autarky, defense, the energy transition, and advancements in AI, particularly for data centers and semiconductors. These initiatives have substantially boosted the demand for metals.

A prime example is copper. Jeff Currie recently highlighted that policies focused on redistribution, environmental sustainability, and deglobalization have made copper "the best trade he has ever seen." This sentiment is echoed by BHP Group's nearly $43 billion takeover bid for Anglo American, driven primarily by Anglo American's valuable copper assets. The following graph illustrates the structural increase in copper prices over recent years:

Sources: Bloomberg Finance L.P., Dasym

In recent years, similar narratives have emerged about other metals such as nickel, cobalt, and lithium, driven by their critical roles in systemic transitions. All three metals are essential for batteries and electric vehicle production, underscoring their growing importance in the energy sector.

However, what these financial market narratives often overlook is that metals, as materials used by engineers, are subject to unpredictable changes. Consider the following two examples:

  1. Over the past five years, LFP batteries—which use lithium but neither nickel nor cobalt—have transitioned from a niche product to capturing more than 40% of the EV battery market. Previously, NCM batteries (which use nickel and cobalt) were believed to become the industry standard. This shift has significantly impacted the strategic position of Indonesia, a dominant producer of both nickel and cobalt.
  2. With copper prices exceeding $10,000 per ton, the incentive to use alternative metals has grown. Copper is the most popular conductor of electricity due to its high conductivity and relatively low cost (only silver conducts electricity better, but it is much more expensive). However, aluminum, priced at around $2,600 per ton, can serve as a substitute for copper. Some researchers argue that up to 90% of the copper used in electrical applications can be replaced by aluminum.

Given the structural shift toward government policies that increase the demand for metals, many investors anticipate a continued rise in commodity prices. However, the inherently unpredictable nature of engineering solutions—especially as prices climb—means investors should be prepared for higher volatility in metal commodity markets. Consequently, instead of relying on long-only investment strategies that bet on sustained price increases, investors might be better off investing in commodity trading firms, which are better equipped to navigate and capitalize on market fluctuations.


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