Investment Opportunities as Demand for Commodities Grows

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Welcome to Advisor To Go, brought to you by CIBC Asset Management, a podcast bringing advisors the latest financial insights and developments from our subject matter experts themselves, 

Éric Morin, senior research analyst covering Asia at CIBC Asset Management.  

So far this year in 2024 in the first three quarters, lower and recently negative energy inflation has contributed to reduce headline inflation. But when we think about commodities, we also have to think about food. So, for example, food inflation, which is the output of several commodities, has remained sticky and stubborn above the 2% target, meaning that it has remained increasingly costly to produce and transport food, a trend that should remain.  

That’s the past. Commodities and inflation can be highly volatile and highly cyclical, and what matters really is the outlook.  

So, the outlook for both inflation and commodities? Well, both inflation and commodities are highly correlated. So, what matters for one, matters for the other. And our outlook is that inflation should remain above the targets of many central banks over the medium term, and inflation should also remain a risk for investors.  

So, the good news is that that outlook is partly because of strong demand for investment and commodities. So, we talk about housing, public infrastructure, and also the rise of India. So, under that inflationary story, we have a good macro environment for investors with strong investment across the globe.  

The less good news or the bad news is that we do expect commodities to make a positive contribution to sticky inflation. So, after the great financial crisis, for nearly a decade, commodity prices were posted really low inflation. What we think for the next decade and for the next five years is that commodities inflation will look more normal. And because of that, we do expect commodities to make a more positive contribution to sticky inflation.  

Demand and supply forces should keep inflation above target and commodity demand elevated. So, on the demand side, we have geopolitical risk, housing shortage and a need for significant infrastructure investment, including renewable energy.  

So geopolitical risk is a reason to expect strong investment. So, there is a bipartisan consensus in Washington that China presents national security and defense risk over the long term. And also, there is a competition consideration there on the tech front. And in this context, we do expect technology and manufacturing investment to remain strong, and that should keep pressure on inflation ongoing. So, this is the reason why we are upbeat on investment.  

The other reason is there is a big shortage of housing. So, housing shortage has been an important source of inflation being elevated in several countries, including the U.S. and Canada. And insufficient housing should remain over the next several years. We estimate that it will take about three to five years of new investment to restore a more reasonable balance in the housing market in Canada, in the U.S. So that means also higher inflation. And for investors it does matter, because inflation should remain a concern, and because commodities are highly correlated with inflation, commodities is a solution or something to take into account in the construction of a portfolio.  

The other factors are public infrastructure gap. So, according to the American Society of Civil Engineers, there’s a substantial proportion of U.S. surface transportation and water infrastructure that is reaching the end of its lifespan. And this, according to them, will require investment of more than 10% of GDP in the U.S. And we do consider that similar needs exist in other DM countries, such as Canada.  

And last but not least, there is the renewable energy transition. This is another investment intensive theme. It’s going to bring upside pressure on the output gap, meaning that the economy should continue to run at the pace or at the level that is above its potential. That’s the first reason. And the other reason is the renewable energy transition should result in strong demand for several commodities, pushing the price of many commodities higher. 

According to joint work by the IMF and the International Energy Agency, their work suggests that renewable energy investment will more than double over the next few years, and we should consider this as a big stimulus when we look at the macroeconomy. So, it’s going to have the same impact as a big fiscal stimulus. 

And it’s also the case for power grids. So globally, there will be a lot of much higher demand for electricity because of the energy transition, because of EVs — electric vehicle — because of booming demand from data centre. And this is an issue, because globally, the power grid systems are not sufficient, are not adequate for future demand. And this will require a lot of investment globally that could exceed 2% of global GDP.  

So, the point there is that this is another big stimulus that will boost investment and will boost demand for commodities. 

India’s economic rise matters for commodities, and it will increasingly matter. So, if we look at the big picture, India will likely soon overtake China as the world’s economy growth engine. So, in terms of contribution to global economic growth, we expect India to become the biggest driver of global growth, and it will likely contribute to about 25% of economic growth over the medium term, and the contribution to global energy demand will be bigger than that. Our outlook is that India will contribute to nearly one-third of incremental energy demand in the next 10 years.  

So, there’s strong demand for commodities, for all commodities, because India has a large population that is young, and the urbanization rate is really low. So, for example, their urbanization rate is at about 36%. This is well below the 64% that prevails in China. And this is important, because over the past two, three decades, the economic rise of China was made possible because of an acceleration of urbanization, and this entails a lot of investment demand for infrastructure. It was extremely demanding for commodities. And what we do expect is that the rise of urbanization in India will require, or come with, a lot of demand for several commodities.  

The commodities that will be the winners from India’s rise — there is a lot of them. Coal is one of them. There is also copper, lead, nickel, all of them are major input to the energy transition. So, the rise of India will, in fact, bring upside pressure, not only of the commodities that I’ve mentioned, but in most commodities, including gold, because gold is culturally important in India. It is a way to store value. And the rise of India and the rise of wealth in India should come with important upside pressure on gold prices.  

So, we’re relatively upbeat on several commodities.  

And another point that is important with India is that, because its power grid network is deficient, and given the high reliance of the country on coal, we see a limited penetration of electric vehicles in India. And this is important because demand for oil coming from India should increase at an important pace looking ahead, and that should mitigate or reduce the downside pressure on energy inflation, oil inflation, coming from the global energy transition.  

So, India will provide a tailwind to several commodities and will limit the downside on oil inflation, because India is in no position over the medium term to accelerate materially its transition toward electric vehicles. So, this is an important factor.  

We see three advantages of having commodities in the portfolio. The first one is that it’s going to provide a hedge against inflation and a hedge against geopolitical and climate tailrisk. The other characteristic is that it should improve portfolio diversification. And last but not least, an allocation to commodity may also enhance expected return.