Commodity Investing in a Shifting World Order Opportunities for a dynamic and tactical approach


Marwan Younes, President and CIO, Massar Capital Management


Management and Graham Capital Management. Massar runs over $1 billion in discretionary macro strategies.


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Younes sees economic shifts, policy shifts and slowing growth creating a more volatile and sometimes unpredictable climate for directional and relative value investing in commodities, but a rich opportunity set for nimble traders who can think outside the box and be open minded about new ways of modelling markets.


Deglobalisation Decades of globalization, declining trade barriers and tariffs and increasingly integrated supply chains, has at least paused if not reversed. Trade intensity, as measured by export and import shares of GDP, has been falling in nearly every major economic region, and even in the most open economies flat intermediate inputs reveal supply chain fragmentation.


The rise of electric vehicles – forecast to reach 17% of car sales by 2030 - is one example of a consumer trend which could contribute to deglobalization, as it reduces demand for oil and also auto-parts, since EVs use much less parts that ICE vehicles.


Deglobalisation is also driven by political extremism, which is partly caused by stagnating middle class incomes and increased inequality since the 1970s. The constituency in favour of free trade has collapsed everywhere except for a few very open economies. Nearly every major economic region is seeing more political polarization, which has reached a 50 year high, as measured by indices such as V-DEM varieties of democracy. This leads to more trade barriers, protectionism and isolationism.


Slowing China Meanwhile, economic growth in China, the largest locomotive of global growth, is expected to slow to less than half of its pre-Covid level. China has massive debt to GDP including private debt after malinvestment; and demographic challenges from low fertility rates and a population projected to shrink.


Geopolitics A growing number of wars and conflicts are another challenge. The number of countries contributing


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arwan Younes founded Stamford, Connecticut based Massar Capital Management in 2015, having previously worked for Jamison Capital


troops to conflicts has risen from around five per year from post-World War II to the early 1990s to between 70 and 80 per year over the past decade, including internal, inter-state and internationalized conflicts. Clearly, countries with high political risk eg Russia, Iran, Libya, Algeria, are significant for global exports of many commodities such as oil and gas.


All of this is set to make commodity prices structurally more volatile than pre-Covid, raising the baseline of volatility and creating two-way volatility risks as well as dislocating relative value relationships within commodities.


Geopolitical risk is not always necessarily bullish – the US/China trade war in 2018 imposing tariffs on soybeans resulted in a price dump.


Unprecedented relative value dislocations Russia’s invasion of Ukraine severely disrupted normal relative value in global wheat markets. The calendar spread between July and December Chicago wheat jumped close to three dollars, having never previously exceeded 15 cents, as those with physical exposure to Russian wheat needed to hedge. Meanwhile the normal quality premiums reversed. High quality, high protein Matif wheat, used for bread and human consumption, went to a 50 cent discount versus low quality, low protein Chicago wheat, which is used for animal feedstock. This happened despite the fact that Matif wheat can be delivered into the Chicago future.


Non-linear modelling Commodity traders need to rethink their models. Traditional linear modelling is standard, but does not work in extreme scenarios or at fringe price areas, when non-linear phenomena come into play. When prices change the rules change.


For instance, regulatory price caps in Spain and Portugal resulted in a negative spark spread of electricity versus its cost of production using natural gas prices in June 2022.


There are also data challenges. Bloomberg shows a peak nickel price of USD 55,000 when using end- of-day price data, although large volumes traded at USD 100,000 on March 8th 2022 intraday during the morning hours amidst a massive short squeeze. The London Metals Exchange ended up cancelling a large amount of trades above USD 50,000 from that morning, but it is important to have the data available from these extreme events.


Investors also need to model mean reversion outside a linear framework. For equities, higher prices generate positive feedback loops of raising capital and growth. For commodities, higher prices incentivize supply, substitution and destroy demand. After the 1970s oil price shocks, the US introduced fuel efficiency rules and average miles per gallon for new cars rose from below 15 to above 23 by the early 1990s. Gasoline consumption also took 10 years to return to its previous peak after the implementation of the new fuel efficiency standards.


Static, linear supply/demand projections overlook three components of price shocks: permanent, risk premia related and frictional or transitional.


Taking Russian oil as an example, the permanent impact is that some barrels are now absent. The risk premia impact is that costs of freight need to reprice to allow for more expensive and less easily available insurance. The frictional impact is around rewriting contracts and reconfiguring supply chains. Western European oil refineries had been optimized to maximise yield from Russian oil and will yield less when using inputs of US or Saudi oil. It takes 6 to 12 months to reconfigure refineries to different types of oil, during which time less diesel is produced.


Commodity investors should expect more frequent shocks with a much wider range of uncertainty. They should probably run lower volatility to keep dry powder for taking advantage of opportunities. Liquidity has dropped dramatically and when it disappears there should be enough time to work out what the new roadmap is. A nimble, dynamic discretionary approach is needed because these new patterns and relationships cannot be modelled systematically across a range of markets, and market responses may even seem counter-intuitive.


Imbalances often do not unfold as expected. The IMO ban on high sulphur fuel for example, which came into force in 2020, was widely expected to cause a spike in diesel prices, but they actually sold off. There are always multiple variables to juggle, including demand, regulations, substitution, and technology.


There are very optimistic forecasts for metals used in electric vehicles, but it is very rare for commodities to go up fivefold in response to demand and much more likely that they see a small short term spike. THFJ


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