The Factory Daily Letter

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The clues in commodities

From inflation concerns to recession fears

While equity markets have been showing signs of stabilization over the past week, global commodities (particularly the more cyclical) have moved significantly lower. 2022 has not been short of volatility thanks to the war in Ukraine and the evident persistence of inflation pressures (and given the uncertain outlook, the volatility looks set to continue). However the global hawkish shift in monetary policy on the part of the central banks now wrestling with that inflation has been bringing about a shift in the market dynamics - now that recession concerns have started to gain traction.

The chart below shows the price action of various asset classes across the three large selloffs the S&P500 index has suffered since January – and it illustrates how inflation fears have been giving way to recession concern. During the first two corrections (January and March) it was the long-duration pockets of the market (such as the Nasdaq / growth names and tech) performed worst – suffering the rising inflation expectations and yields. But in the June correction it was they that proved the more resilient, outperforming the broader market as the upward momentum in yields moderated.

Moreover, during the March correction the 10s2s Treasury curve steepened 17bps, the growth outlook perceived as robust enough to withstand a Fed hiking cycle. But as we recall the CPI release ahead of the June meeting revealed that inflation was still running higher than expected – forcing the Fed to adapt forward guidance to make price stability its main objective. The yield curve flattened (inverting on 13 June for the second time this year – the first time being 30 March) and inflation expectations fell 17.7 bps with the more cyclical pockets of the market (that offered a good hedge during the first two corrections) capitulating: energy stocks, (-15.6%) and materials (-14.9%) down significantly in the June selloff. Most of the commodities space also lost ground with the Bloomberg commodity index down -4.5% as recession fears mounted:

Source: FactSet; Pictet Trading Strategy; as of 28/6/2022.

While we are likely to see the more hammered corners of the commodities space rebound from such oversold levels in the short term (each commodity of course subject to its own specificities), rising concerns about the consequences of an economic slowdown diminish the prospects of a rebound in commodities that proves hugely significant and lasting. However (and perhaps counter-intuitively) the reduced pricing pressures that could result from lower commodities prices could bring a short-term tailwind to equity markets – the prospect of lower inflation numbers in turn likely to ease the pressure on yields and dampen the Fed’s extreme hawkish tilt.

Source: FactSet; Pictet Trading Strategy; as of 28/6/2022.

While the long-term trend in commodities has been positive, 2022 has had something different in mind: for the first time since the Covid-crisis struck at the beginning of 2020 commodities – globally - have broken their uptrends. While precious metals have proven more resilient in this recent sell off, the more cyclical commodities have been suffering most from the recent recession fears. The industrial sub index for instance has now fallen 30% from its March high. Even the more energy-linked commodities (i.e. those most exposed to the Russian/Ukraine conflict) have eased recently, with crude oil now significantly down off its 2022 highs. The Bloomberg energy sub-index (in pink) is negative MTD and could be on the eve of posting its first negative monthly return in 2022;

Now that the trends in commodities have shifted, they no longer act as a hedge

By way of the table below we present how the commodities futures that make up the Bloomberg Commodity Index have evolved. It demonstrates how over the past year (and since the Covid recovery began) futures have risen with demand, on speculation, and likely as an inflation hedge (the average one-year price change remains high (+31.5%); yet more recently the trend has turned negative (i.e. 3-month) reflecting the rising recession risk, and the global risk-off mood. In fact, since Russia first invaded Ukraine on 24 February, futures prices have been falling across the commodities sphere – the energy sub sector being the exception (with crude oil, gas and gasoline prices are still higher than the pre-war levels). More recently, it has been the cyclical metals such as Nickel (LN1) and Copper (HG1) that have been suffering (again now that the spectre of recession has emerged). While Nickel, Zinc (LX1) and Aluminum (LA1) – that make up the industrial metal sub index - remain above where they were a year ago, copper is now in negative territory across all of the six selected periods in the table.

Overall, the proportion of commodity futures posting negative returns has been growing sharply since the beginning of the year (from 30.4% to nearly 83% over the past month). Gold remains one of the only commodities that has managed to remain stable over recent days.

Source: FactSet; Pictet Trading Strategy; as of 28/6/2022.

Recession fears vs metals prices

As we discussed in our recent letter on recession risk, recession odds have been on the rise over the past weeks as the persistent evidence of higher inflation forces the Fed to continue its (more aggressive) tightening cycle – one which could lead to an economic recession in the medium term. Over the past six months, the probability of the US falling into recession as presented by the St Louis Fed has risen from 10% at the end of last year to 33% as we write.

As is illustrated on the graph below, the Bloomberg Industrial metals index (a sub-index of the Bloomberg Commodity index) has historically tended to suffer as recession odds have been rising. Recently, this inverse relation has prevailed, the industrial metals sub-index having suffered a decline of more than 25% since the end of March putting the index on track for its worst quarter since 2008:

Source: FactSet; Pictet Trading Strategy; as of 28/6/2022.

The copper vs gold ratio also implies further economic slowdown

The chart below shows how that monthly indicator of US economic activity the ISM Manufacturing PMI index (which is based on a survey of more than 300 purchasing managers) has historically moved in tandem with the copper/gold performance ratio (widely used as a market-based proxy of economic activity). You can see how the copper/gold ratio (in black) has recently dropped (gold outperforming copper), arguably reflecting market expectations of further economic deterioration over the short and medium term. At current levels the historical correlation implies that the ISM manufacturing could fall towards roughly 52.5 (latest reading 56.1). While such level would mean that the US economy was still in ‘expansion’ territory, it is nonetheless much closer to the ‘contraction’ threshold (50).

Source: FactSet; Pictet Trading Strategy; as of 28/6/2022.

Inflation expectations and commodity prices

As we also discussed recently, that US inflation expectations recently stabilised could provide some support (relief) to the equity price action over the short term. Inflation expectations also have a close relationship with commodities and we present below the Bloomberg commodity index (one-year change) together with the US 10-year breakeven inflation (one-year different) rate since January 2020.

Over the past two and a half years, strong global demand and rising inflation has led to a sharp appreciation in commodity prices, but easing inflation expectations (likely due to ongoing Fed’s monetary tightening and fears of a potential recession) now appears to be taking effect in commodities - albeit with a bit of a lag:

Source: FactSet; Pictet Trading Strategy; as of 28/6/2022.

The recent change in the Bloomberg Commodity index implies lower yields

Over the past two years, US yields have been trading in an upward trend as rising inflation and stronger economic growth have supported higher yields. In November 2021, the hawkish rhetoric from the Fed and other central banks sparked further rises in yields across bond markets. More recently, Fed tightening has exacerbated the trend, with the US 10-year Treasury yield reaching nearly 3.5% before retracing slightly to just above 3.20%.

As shown on the graph below, the 9-month change in the Bloomberg Commodity index has been moving in tandem with the 9-month difference in the US 10-year Treasury bond yield.

However recently the time series have started to diverge, the commodity index moving lower compared to its level reached 9 months ago - while US 10Y yields have remained relatively unchanged.

This broken correlation could be explained in our view by the fact that market participants may now be anticipating further deterioration in the economic cycle, which may drive yields lower (something that could provide further support to equity markets in the short-term).

Source: FactSet; Pictet Trading Strategy; as of 28/6/2022.


The recent weakness in the commodity market could help ease inflationary pressure in the short-term and drive US yields lower. While the peak inflation may be behind us (as inflation rates in the US have remained relatively stable recently) it could be some time until we reach ‘peak hawkishness’ on the policy front. However, easing pressures from the commodity market may nonetheless help encourage the Fed to adopt a slightly less hawkish tone in the weeks to come, and accordingly offer some significant relief for the equity market.

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