With agricultural prices soaring, metal prices hitting multi-year highs and oil prices well above $50, JPMorgan Chase believes: commodities have entered a new super cycle that will last for years.
J.P. Morgan quantitative analysts, led by Marko Kolanovic, said in a report released Wednesday that commodities could see a long-term boom as Wall Street bets the economy will recover strongly from the Epidemic shock and hedge against Inflation risks.
JPMorgan Chase is bullish on energy and metals. The bank believes that oil prices could soar as an “unintended consequence” of the response to climate change, as initiatives to address climate change could threaten oil supplies, leading to the unintended consequence of higher oil prices.
At the same Time, people will respond to climate change and build some of the infrastructure needed for renewable energy, batteries and electric vehicles, thus triggering a lot of new demand for metals.
It’s worth noting that it’s not just JP Morgan that is currently bullish on a new super cycle in commodities, it’s safe to say that almost the entire Wall Street holds similar views. Recent bearish research reports have been published, including Goldman Sachs, Bank of America Merrill Lynch, Citi and other sellers, but also include Ospraie Management LLC and other buy-side institutions.
In addition to the reasons listed above by JPMorgan Chase, also include global central banks and fiscal “watering”, the economic recovery brought by the popularity of vaccines, the weakening of the dollar, etc..
Wall Street News mentioned that the China Merchants Securities Xie Yaxuan team had predicted in mid-December that the market would usher in a nine-year-long bull market in commodities. The reason is that the dollar will enter a 9-year weak cycle driven by unlimited quantitative easing by the Federal Reserve, and historically, there is a “seesaw” effect between the dollar and commodity prices, with commodity price highs expected to rise step by step.
Bloomberg said this widespread market optimism has driven the hedge fund industry’s bullish bets on commodities to the highest level in 10 years, in contrast to the pessimistic expectations of the global market last year when the epidemic first began to sweep the world, especially when oil prices fell into eye-wateringly negative numbers.
“Hedge funds haven’t been as optimistic about commodities since the 2000s.” The Bloomberg article reads.
“The up cycle is here.”
A group of JPMorgan analysts led by Marko Kolanovic made a rather bold prediction in their research report.
We believe that a new cycle of price increases in commodities, particularly in oil prices, has arrived.
History has shown that commodities have gone through four more significant super cycles over the past century or so, with the most recent one starting in 1996 and stretching for 12 years, finally peaking in 2008.
Everything today looks like it did a dozen years ago, with global commodity prices rising sharply, from copper metal to cotton, from Crude Oil to Food, and the Commodity Composite Index has surged to a rare six-year high, with oil prices already 64% higher than last November.
JPMorgan said the main drivers of that commodity supercycle at the time were high demand from China’s sustained years of high economic growth and a depreciating dollar.
As for the current supercycle, in J.P. Morgan’s view, it originated from the super-easy monetary and fiscal support policies that were fully implemented in major countries around the world after the epidemic, as well as a weaker dollar, higher inflation, and more aggressive environmental policies that were set in motion around the world.
They also suggest a key driver: U.S. bond yields and inflation expectations are reversing.
This cycle is different
In addition to the fundamentals, the factors that have convinced the aforementioned quantitative team at JP Morgan that a new commodity supercycle has arrived include liquidity.
They believe that the next few years will see significant changes in liquidity that will play an increasingly important role in the asset pricing process. This is the result of the electronic supply of liquidity, the increasing popularity of leveraged use, and the rise of systematic trading strategies and related processes.
In JPMorgan’s view, it is these increasingly rapid and intense flows that are “exacerbating the scale and speed of price volatility in commodities and related equities,” and the same flows “can have a similar impact on prices in an upward cycle.
The following are excerpts from some of the team’s key observations.
Inflation hedge: The past decade has been marked by low growth and low inflation. U.S. bonds and some growth stocks are in a long-term bull market, while commodities and cyclical stocks, on the other hand, have not done so well. Today, U.S. bond yields and inflation expectations are reversing, which poses significant risks to multi asset class portfolios, leading to a unified market expectation that “commodities are the best way to hedge against inflation.
Bond-equity correlation hedging: If bond-equity correlation is a key factor in portfolio building, the JP Morgan team found that the correlation reversed when the last supercycle began in 1997. At that time central banks stepped in to intervene in the bond market to prevent risks from erupting in the equity market. Coincidentally, as the commodity supercycle ended, short-term interest rates fell to zero globally, also causing the effect of central banks strengthening the equity-bond correlation without pushing up inflation to be offset. Now, with the world in a “monetarily and fiscally supported economic recovery,” JPMorgan expects volatility to fall and inflation to rise, “with a knock-on effect on bond-equity correlations.” This means that energy stocks will be a good hedge asset against equity-bond correlations, and they will provide yield while hedging against the risks of inflation and equity-bond correlations.
Quantitative and momentum investing: In a market where algorithms and trend followers have become one of the dominant pricing forces, it is natural for JPMorgan to focus their research on their influence as the driving force behind commodity super cycles. They argue that “CTAs have been increasing their energy investments” after “CTA funds played a significant role in the 2014 oil price decline.” The reason for this is that momentum momentum over the next 12 months is favorable to the upside of oil prices and the market outlook is becoming more positive. And a further decline in volatility could lead to larger, more stable quantitative cross-asset allocations. The larger momentum impact could affect energy stocks. Energy stocks are the only sector that still has a strong negative momentum signal and are therefore heavily shorted in the context of factor investing. This will change in mid-March, when the momentum signal will turn in favor of energy stocks.
So just how big will the money flow be?
The aforementioned JP Morgan quant team has calculated that if one roughly assumes that there is about $1 trillion in long-short quant funds in equities, and that half of that is not offset by the sector, then “the flows could be quite large, about $2-3 billion”.
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