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May 4, 2020

Commodities ‘bullwhip’ could crack in other direction

As COVID-19 has stifled economic activity around the world, it has dragged down commodity prices in its wake. The price of oil has been the highest-profile victim, but metals prices have likewise spiraled downward as the demand for steel, aluminum, copper and other metals has dwindled in one nation after another.

The lower pricing was predicted March 2 by Jason Schenker of Austin, Texas-based Prestige Economics. Schenker, who also is chair of The Futurist Institute, at that time mentioned the possibility of a “bullwhip effect,” in which “a small move of the wrist turns into a big crack extending beyond China.”

As COVID-19 “shelter in place” orders hit Europe and then North America, exchange pricing for copper and aluminum tumbled to lows not hit for several years.

One month later, another investment analyst and advisor is pointing to the possibility of the bullwhip cracking in the other direction once economies in Europe and North America follow China in returning to a post-COVID-19 setting.

John Browning of Shanghai-based BANDS Financial writes on April 1 that Goldman Sachs has warned that the economy in the United States “will go through an unprecedented drop” in the second quarter of 2020, but then “will be followed by a recovery that would be the fastest on record.”

Adds Browning in regard to metallic commodities, “Goldman should be careful what they wish for.”

The advisor and trader cites gold as one example that has seen its price shift on different terminal markets, sometimes resulting in curious spreads. Such differences can arise in part because of the differing supply situation from one place to another. As economies recover at different paces around the world, such differences or spreads could be substantial, he writes.

Browning also writes that supply cuts in mined ores and primary metals means that if the bullwhip cracks back to intense demand, prices would rise sharply in lieu of adequate supply. He cites this April 1 observation from Australian bank Macquarie: “As base metals prices test lows and governments curtail activity, a growing number of production assets are going offline, temporarily or indefinitely.”

In his daily email to clients, Browning adds, “The message from the fractured supply lines in metals is that demand is falling, but supply is falling also, so that we must expect short but painful disruptions in available location quality and delivery date. If we were to add this to Goldman’s expectation of a sharp recovery in Q3, it would seem we have the ingredients for an incendiary inflationary cocktail in the commodity space.”

That scenario could create a feast after the famine for scrap recyclers. With a sharp recovery, they can ideally receive an attractive price on any existing inventory. Following that, recyclers can put their supply elasticity benefit to work by drawing increased peddler scale traffic as prices rise and metals producers seek feedstock.

As those same processors and traders struggle in the current low supply and low price environment, the idea of such a rebound presents a glimmer of hope.