The average performance for commodities is around 30% since the beginning of the year. This rebound is particularly remarkable since it has occurred in an environment still dominated by a contraction in the global economy, without any concrete sign of a recovery in physical demand for commodities. In fact, it is not the consumers of commodities that have caused the rebound in prices but investors. Given the nature and scale of the financial and economic crisis, investors have indicated their strong risk aversion by overweighting their portfolios of investments in so-called “risk-free” assets, i.e. cash and government bonds.

They kept this asset allocation until they were convinced that the worst was over and that the global economy was going to start to recover. Consequently, they have adjusted their portfolios by reweighting allocations in assets with a risk premium, i.e. equities, corporate debt, emerging markets and commodities. In light of this situation, the rebound in commodities is no different in nature from the rebound observed simultaneously in these markets in Q2. However, there are four reasons that could have prompted investors to return more specifically to the commodities asset class.

The first signs of an impending economic recovery

These signs emerged during Q2 with what has been called the “green shoots” of recovery. These are no more or less than leading economic indicators (in particular, surveys conducted among consumers, purchasing managers or heads of companies) which have gradually started to reverse, initially in the United States and subsequently in China and Europe. Already in Q2, when they still considered the current situation to be very gloomy, their anticipations for the following months gradually became increasingly positive: economic players were taking on board “V-shaped” recovery scenarios.

However, commodities are also considered to be leading economic indicators simply because they are the first segment in the industrial logistics chain. In logical terms, when industrial companies anticipate an improvement in their activity over the next few months, they rebuild their stocks of commodities even before industrial production recovers. This time, investors have themselves anticipated that industrial companies are likely to rebuild these stocks over the next few months.

Commodities as a protection against inflationary risks

The scale of the public deficits related to economic stimulus plans prompts questions regarding the sustainability of debt servicing. In addition to traditional measures, i.e. tax increases and public spending cuts which everybody knows are difficult to implement, some economists have raised the possibility of letting inflation increase at a stronger rate in order to erode the real value of the stock of debts. Even if inflation does not decide to do so, given the impressive quantity of liquidity injected by the central banks since the beginning of the recession, it would probably be sufficient to keep key rates at their lowest when the economy returns to positive growth for inflationary tensions to appear. This scenario would signify for institutional investors, particularly pension funds and sovereign funds, that the central banks would no longer protect them against inflation.

They would therefore have to cover themselves by resorting to market instruments (inflation swaps and indexed bonds) and according to economic theory, by constituting positions in real assets, primarily property and commodities. Although it is fairly surprising to see this debate on inflation emerge so early in the economic cycle when the short-term risk remains resolutely deflationary, some pension funds have recently increased their allocation in the commodities asset class directly on the back of this inflation theme.

In conclusion, the rebound in commodities in Q2 can be explained primarily by anticipations of economic recovery and, therefore, this rebound can be considered as a leading indicator of this recovery. However, it is actually investors, and not the physical consumers of commodities, that have fuelled this rebound in prices. This logic simply testifies to the fact that, since 2005, investors have played an increasingly important role in the process of commodity price formation, not by integrating a purely speculative component but rather by
integrating an anticipatory component in spot prices.