Commodity prices dropping amid increasing concerns of economic downturn

Commodity prices are plummeting as fears of a global recession loom.

An increase in raw material demand post-pandemic, coupled with the geopolitical disruption wrought by Russia's invasion of Ukraine and other supply chain challenges, pushed prices of many metals to record highs earlier in 2022. Now, prices are pulling back sharply as market observers fear that a weakening economy is heading toward a recession that could reduce demand for a wide variety of products.

"I think the emerging risks of recession, which comes with falling demand for commodities, is the overwhelming factor impacting commodity prices these days," said Mark Ferguson, metals and mining research director at S&P Global Commodity Insights. "Together with current high inflation, there are major concerns on the macroeconomic outlook through 2023."

Analysts worry that falling metal prices are a harbinger of a downturn. The decrease in pricing is weighing on mining equities as well. The S&P Global BMI Metals & Mining Index surged early this year before taking a turn and sharply falling through the summer. As of July 6, the index value was nearly one-third lower than in mid-April.

The falling value of metal "is a clear sign that the global economy is slowing," said Edward Yardeni, president of consultancy Yardeni Research.

Investors are generally tracking commodity prices, and there are concerns that a sluggish economic rebound in China could weigh on metals demand. The country is a commodities heavyweight, and it has been reinstating strict COVID-19 restrictions in recent months. Analysts from Saxo Bank and ANZ Research warned in April that Chinese slowdowns could be a problem for the global economy.

"Commodity prices have gotten everybody's attention, and that's where the focus is. It's kind of a real-time signal of a potential imminent recession," Yardeni said. "That's what we're going to want to keep watching."

Several indicators are suggesting commodity prices will snap back to align more with historical averages after the extreme swings upward, TD Securities wrote in a July 7 note. As prices move quickly downward, commodity holders may be prompted to sell off assets just as quickly, fearing they will not be able to recapture the gains that could have been had when prices were high.

"I think what we're seeing at the moment is probably the deepest capitulation event since COVID-19," said Daniel Ghali, a director of commodities strategy at TD Securities. "That's typically happening from broad commodity funds, which are indiscriminately selling all commodities."

While Europe has received much of the world's attention regarding a potential recession, the problem is global, Chris Weston, head of research at Melbourne, Australia-based brokerage Pepperstone, wrote in a July 6 note.

"In a world of rising interest rates and central banks hellbent on putting the inflation genie back in the bottle, we've seen clear evidence of demand destruction — commodities have been the default expression of this thematic, and right now, there is just no visibility on growth or what changes the trend — even though the market lives in the future, it feels like this gets worse before it turns around," Weston wrote.

Base metals take hit

While supplies are tight and stockpiles are low, base metal prices have plummeted. Copper prices fell by about one-fifth between April and late June.

The anticipation of a slowdown in manufacturing has driven some weakness in markets for other base metals as well, including lead and zinc, said John Ryan, CEO and director of Gold Express Mines, a company that owns or operates more than a dozen active mining properties in five western U.S. states.

Still, Ryan is optimistic that the copper sector will remain strong despite macroeconomic pressures.

"We've had a bit of a sell-off of copper, coinciding with fed tightening," Ryan said. "But when people start really looking at the supply-demand numbers, I believe that the copper prices recover pretty quickly."

The trend has also had an impact on nickel, another base metal. Nickel prices doubled to a record $100,000 per tonne in trading in early March, prompting the London Metal Exchange to suspend trading. The nickel market was in deficit in 2021 and was heading toward a modest surplus in 2022 before Russia, the fourth-largest global supplier of primary nickel, invaded Ukraine.

Prices came off record highs but remained above the levels seen before Russia's invasion. However, investor concerns around central banks' aims to tame rising inflation is pushing prices downward, wrote Jason Sappor, a senior analyst with Commodity Insights' Metals and Mining Research team.

Commodity Insights expects primary nickel demand growth to slow from 15.7% year over year in 2021 to 6.5% in 2022. According to a June report, the global primary nickel market is expected to move to a surplus of 69,000 tonnes in 2022 from a deficit of 160,000 tonnes in 2021 due to slowing demand growth and increasing supply from Indonesia.

"The combination of rising inflation and more contractionary monetary policy will leave consumers with less disposable income," Sappor said. "This would be more fundamentally impactful to the nickel market than to construction-focused metals such as iron ore because consumer activity accounts for a large proportion of nickel end-use demand."

Gold drifts back below $1,800/oz

Gold, often viewed as a safe investment in times of volatility, has held up relatively well through the year. However, prices have recently taken a plunge below $1,800 per ounce as investors assess options to deal with rising interest rates, higher inflation and geopolitical risks in the second half of 2022.

Interest rate hikes could create headwinds for gold in the second half, but many investors have already priced that in, according to the World Gold Council. In its latest outlook, the organization said it expects inflation and geopolitical risks to sustain demand for gold as a hedge. Underperformance in stocks and bonds could also drive investors to gold.

"Historically speaking, gold has tended to perform positively in periods of systemic risk and recessionary periods, in part because it's a high-quality liquid asset that investors flock to," said Juan Carlos Artigas, global head of research at the World Gold Council.

Lithium stays strong

Lithium, a key material used to make batteries, has been more resistant to the trend of declining prices.

In May, the seaborne lithium carbonate CIF Asia price declined for the first time since November 2020, falling $500/t, or 1.0%, month over month. However, that price assessment remains more than six times higher than the year-ago period.

Commodity Insights expects short-term lithium prices to continue benefiting from pent-up demand in China into July. Later in the year, new mines in Argentina and Australia could increase supply volumes, combining with macroeconomic trends to soften prices.

Still, continued policy support for passenger electric vehicles is likely to continue to increase demand for battery metals such as lithium and cobalt, Commodity Insights senior analyst Alice Yu said. The full-year demand outlooks for both metals are still down from expectations at the beginning of the year. Continued policy support for passenger EV rollout will nevertheless continue encouraging uptake over the long term.

"A softer macroeconomic environment is reducing discretionary spending on cars and electronics; passenger electric vehicle and battery production have declined on the fallout from Russia's invasion of Ukraine and lockdowns in China," Yu wrote. "We thus expect a broadly declining trend in lithium and cobalt prices in the second half, on weaker demand."

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