Commodities ripe for a rebound

Business

FILE – In this April 17, 2020 file photo, the sun sets behind an array of pump jacks outside Midland, Texas. The near shutdown of the economy in response to COVID-19 has reduced demand for oil, lumber and other commodities, sending their prices sharply lower.  Energy has borne the brunt of the selling, with the price of U.S. oil for May delivery plunging last week below zero for the first time. (Eli Hartman/Odessa American via AP)

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LOS ANGELES (AP) — The near shutdown of the economy in response to COVID-19 has reduced demand for commodities like oil, lumber and copper and triggered sharp drops in their prices, but some analysts predict the stage is set for a rebound.

Energy has borne the brunt of the selling as cars stay parked longer, airlines cut back on flights and cruise ships remain idle. A collapse in crude oil prices stunned the market last week as U.S. oil futures for May delivery plunged below zero for the first time ever. Oil is down about 78% this year.

Other commodities are also mostly lower. The Bloomberg Commodity Index, which tracks a diversified basket of commodities, is down 25.7% this year and hit its lowest level ever last month.

Even so, the sharp drop in prices could pave the way for a long-term rally for commodities, analysts say, noting that commodity prices have been mostly declining for nearly a decade because supply has been exceeding demand.

“What we’ve seen in 2020 is just an extension of what’s been happening over the last decade,” said John LaForge, head of real asset strategy at Wells Fargo Investment Institute. “We’ve gone through the crashing phase of commodities and now we’re probably where prices are pretty close to turning.”

Benchmark U.S. crude for June delivery settled at $12.34 a barrel on Tuesday, down from over $60 a barrel in January. U.S. shale oil producers need the price per barrel to average $45 in order to break even.

Last month, LaForge upgraded commodities from neutral to favorable within a 6- to 18-month time frame, noting that the extreme drop in commodities prices this year is the key to eliminating excess supply that has kept prices down for years.

“As bad as all this sounds, keep in mind that what is bad for the commodity producer is not necessarily bad for the commodity price,” LaForge wrote in a recent research note. “In fact, the opposite is often the case.”

Plunging prices and an oversupply of oil with nowhere to store it could be setting the stage for a pullback in supply as producers, especially those in the U.S., pile up losses.

Other commodities are also down sharply this year, though not nearly as much as oil.

Livestock prices have fallen sharply due to disruptions in global supply chains and elevated U.S. supply, noted Giovanni Staunovo, commodity analyst at UBS Global Wealth Management.

Prices for base metals and crops have also taken a big hit.

Staunovo expects that copper and other metal prices will dip below the lows from 2015 and 2016.

“Such levels offer investors the opportunity to pick up some broad metal exposure,” he said.

Meanwhile, panic buying pushed the price of wheat, rice and coffee higher in March, while cocoa, cotton and crops correlated with oil prices such as corn and sugar languished.

All told, corn is down about 20%, while the price of soybeans is off 13%. Prices for live cattle are down 33%, while lumber has fallen about 28%.

Among the bright spots: orange juice is up 14%, while rough rice is up 11%.

Another exception is gold, a go-to asset for investors during economic and market uncertainty. Traders anxious about a deep recession and lengthy downturn for stock prices have driven the gold price about 13% higher so far this year. And the precious metal could see further gains as ultra-low yields for government bonds make gold more attractive to investors.

Commodities tend to go through lengthy boom-and-bust cycles. As commodity prices climb, producers have an incentive to increase supply. Eventually, however, supply begins to outweigh demand, leading to a slide in commodity prices.

In the short-term, big demand shocks like the Great Recession or the current economic crash will drag commodity prices lower. But over several years, it’s supply levels that tend to dictate prices for commodities.

“If you go through 10 years where commodity prices are going down, down, down, eventually you’re going to reach a point where there hasn’t been enough investment,” LaForge said. “And then you don’t have enough supply.”

LaForge expects that commodity prices will perk up by the end of this year as production slows, shrinking the supply.

While noting that commodity portfolios typically carry more risk, he advises clients that want to bet on a commodity price rebound to invest via exchange-traded funds, or ETFs, which hold an array of commodities.

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