The Fed Funds Rate has increased from zero in March 2022 to a midpoint of 5.375% in August 2023. Quantitative tightening pushed interest rates higher further along the yield curve. Meanwhile, a 30-year fixed-rate conventional mortgage that was below 3% in late 2021 is now over 7.5%. New borrowers on a $400,000 mortgage pay more than $1,500 monthly more in debt servicing costs.
Commodities are interest rate sensitive assets. Higher rates are bearish, and most raw material prices have declined from the 2022 highs. The latest comments from Fed Chairman Jerome Powell at the annual Jackson Hole, Wyoming gathering, reiterated the central bank’s commitment to battle inflation with hawkish monetary policy. However, the rate environment is only one part of the story. The geopolitical landscape and other factors could mean commodities will find higher bottoms and could move back toward the highs over the coming months.
Oil and gold prices fall from the highs
A hawkish Fed has weighed on gold and crude oil price.
After reaching $2,129.70 per ounce on May 4, 2023, gold prices fell as the Fed continued to increase short-term rates and the quantitative tightening program reduced the Fed’s swollen balance sheet, pushing rates higher further out on the yield curve.
The chart highlights COMEX December gold futures’ 7.3% decline to the $1,973.90 level on August 30. The continuous gold contract peaked at $2,072 per ounce in May 2023 and March 2022, creating technical issues for the precious metal as the double top is a bearish reversal pattern. The continuous gold futures contract fell to $1,884 in August 2023 before recovering to over the $1,945 level.
Crude oil fell steadily from its March 2022 fourteen-year high.
The chart highlights NYMEX crude oil’s plunge from $130.50, the highest price since 2008, to $63.57 per barrel in May. Over the past months, nearby crude oil prices recovered to over the $81 level, where it is consolidating in late August 2023.
Copper and lumber prices have declined
Copper reached a record $5.01 per pound high in March 2022.
The continuous COMEX copper futures chart shows the decline from the all-time peak that took the red nonferrous metal to a $3.15 per pound low in July 2022. Copper fell more than 37% in four months as U.S. rates increased. Copper has recovered to near the $3.80 level.
Lumber futures are highly illiquid as they suffer from low volume and open interest, the total number of open long and short positions. Rallies or declines in illiquid markets can create price gaps and significant percentage moves.
The CME delisted random-length lumber futures in 2023, but they had risen to $1,477.40 per 1,000 board feet in March 2022.
The chart shows the new physical lumber contract at the $514.50 level on August 30 was over 65% below the March 2022 random-length contract high. Lumber is particularly interest rate sensitive as wood is a primary ingredient in new home construction. However, like gold, oil, and copper, rising interest weighs on lumber prices. It increases the cost of carrying inventories, increases financing costs, and causes investment capital to flow to fixed-income assets as yields rise.
The four reasons why higher rates may not continue to weigh on prices
While higher rates tend to be bearish for commodities, 2023 is no ordinary historical period. History tends to repeat, which is why commodity prices corrected, but the future is uncertain as U.S. interest rates are only one piece of a complicated worldwide fundamental puzzle. The four factors that could cause commodity prices to rise even as interest rates sit at the highest levels in years are:
- Geopolitics: The bifurcation of the world’s nuclear powers distorts traditional supply and demand fundamentals. Sanctions and retaliatory measures can create raw material gluts in some regions and shortages in others, leading to increased price volatility.
- Inflation: While the Fed is combatting inflation with hawkish monetary policy, the cross-border considerations make some of the economic condition’s root causes above the central bank’s pay grade. A 2% target could be too aggressive given the changes in the worldwide landscape.
- Population: Global population has reached the eight billion level. Sixty years ago, it was at around three billion. The rising population increases the demand side of commodity fundamental equations. Supply must keep pace with the rising demand, which will likely push prices higher.
- Climate change: Addressing climate change is distorting traditional commodity fundamentals. Biofuel production increases the demand for agricultural products. While the U.S. and Europe spearhead climate change initiatives, China, and India with over one-third of the world’s population, continue to consume fossil fuels. Moreover, inhibiting U.S. hydrocarbon production returned pricing power to OPEC+, the international oil cartel, and Russia. The cartel’s mission is the highest possible price that balances supply and demand fundamentals. Saudi Arabia requires $80 per barrel meet its budgetary obligations. Russia depends on fossil fuel revenues to fund its ongoing war in Ukraine. Climate change initiatives that inhibit U.S. output contribute to higher prices as crude oil and gas continue to power the world. Meanwhile, the green energy revolution also increased the demand for metals like copper that Goldman Sachs calls, “the new oil.”
The bottom line is that rising rate will not necessarily cause commodity prices to swoon. Moreover, the trajectory of U.S. interest rate increases is likely to slow from the significant increase from March 2022 through August 2023. As rates stabilize, commodity prices could increase as the markets digest and adjust to the new rate environment.
Rates are critical, but so is the U.S. dollar
Higher U.S. interest rates supports the U.S. dollar against the other world reserve currencies. In 2022, the U.S. dollar index rose to the highest level in two decades.
The chart shows the dollar index’s rise to 114.780 in September 2022, the highest level since 2002. Since then, the index declined 10.2% to the 103.02 level, after probing below the 100 level in July. Since the dollar is the world’s reserve currency, it has traditionally been the benchmark pricing instrument for cross-border transactions.
The BRICS countries have been moving towards a gold-backed BRICS currency to challenge the dollar’s dominant role. Saudi Arabia has sold oil to China for yuan, and other oil-producing countries have sold oil to India for rupees. The BRICS countries have addressed the U.S. sanctions on Russia with an initiative to prevent U.S. interference with world trade when conflicts arise. Meanwhile, an alternative to the U.S. currency will limit its role in worldwide trade, making commodity prices less sensitive to dollar volatility. Moreover, as the dollar losses influence, dollar-based commodity prices could rise.
A buying opportunity for the leading commodities
I view the recent selloff in commodities as a golden buying opportunity. Markets reflect the economic and geopolitical landscapes, which remain highly uncertain in late August 2023. Global shifts will likely support higher commodity prices over the coming months and years, as the U.S. influence declines.
I am a buyer of energy, metals, precious metals, and agricultural commodities on price weakness. Even the most aggressive bull markets rarely move in straight lines, and selloffs can be fast and furious in the commodities asset class. However, the bull market that began in 2020 as the global pandemic gripped the world, remains firmly intact in 2023. I expect raw material prices to increase, even if rates remain stable or edge slightly higher over the coming months. Any significant rate hikes could cause selling, but those corrections will likely be more buying opportunities for the products that feed, fuel, and shelter people worldwide.
On the date of publication, Andrew Hecht did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
