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© Aadil Mir Rising fuel price to have cascading effect on essential goods, limit purchasing power of consumers: Dow’s Fiona Boal

One of the abiding worries in recent months on economies and the markets has been spiralling inflation. Rising global petroleum prices have triggered an unprecedented rise in fuel prices in India and resulted in a cascading effect on the value of other essential goods such as food, consequently limiting the purchasing power of consumers, according to Fiona Boal, Head of Commodities and Real Assets, S&P Dow Jones Indices.

Technology has worked against commodities, either by encouraging substitution or improving productivity and thereby requiring less of certain raw materials to meet demand. But in the case of decarbonization, the adoption of green technologies signals strong demand for many commodities.

Green premiums are one-way physical market participants that can signal their willingness to attribute financial value to carbon, Boal told Moneycontrol in an exclusive interaction. Edited excerpt:

What have been the drivers behind the recent rise in commodity prices? Is the reopening of the economy in different parts of the world and the prolonged aggressive fiscal and monetary policy implemented by most countries the primary factor behind the recent price rally and whether we have entered a commodity supercycle?

The S&P GSCI rose 31.4% in the first half of 2021, outperforming the S&P 500 which rose 15.2% over the same period. The S&P GSCI has more than doubled since making an all-time low during the initial stages of the COVID-19 pandemic in April 2020. Several commodities have made new all-time highs this year, as the global economy has reflated, consumer confidence hit pre-pandemic highs in many regions and supply chains remained disrupted.

The post-pandemic recovery in commodities prices has been strongest in the petroleum and industrial metals sectors. Industrial metals continue to benefit from the world’s largest economies building back greener from the COVID-19 shock, while miners and investors remain reluctant to expand supply, despite the surge in prices. Aggressive fiscal and monetary support has also supported the recovery in industrial commodity prices.

What is the role of the Chinese economy? From one side, we see China’s increasing demand for commodities, and most recently, we have witnessed Beijing introducing measures that aim at limiting commodities trading. Your view on how long can Beijing be able to control prices of industrial commodities and if not does the next round of commodity supercycle resume.

Unsurprisingly China is the biggest importer and consumer of many commodities, ranging from iron ore and copper to cotton and soybeans. It has played an important role in kickstarting the recovery in commodity prices post-pandemic. But it is becoming increasingly concerned with the speed of rise and the absolute level of commodities prices. But Beijing’s focus on curbing speculation may do little more than reducing liquidity on the local exchanges and reduce onshore metal stockpiles, which could have the unintended impact of putting upward pressure on prices in an already tight market.

Interestingly we see that gold has been missing out on the commodities rally. How can we explain this?

S&P GSCI Gold declined 7.0% over the first six months of 2021, after an impressive rally last year (+21%). Whether looking for an inflation hedge, store of value, way to diversify, or directional play in commodity markets, gold is the asset with the longest track record of price appreciation in human history. But that does not mean that it is always in favour of investors.

Arguably gold is now pricing a Goldilocks scenario of strong and coordinated economic growth with little risk of prolonged inflation, implying limited demand for it as either a defensive asset or inflation hedge. Renewed strength in the USD and the continued market appetite for risk assets has switched market participants’ attention away from the yellow metal.

To what extent rising inflation may affect commodities, especially gold in a price-conscious Indian market.

One of the most common justifications for a long-biased exposure to commodities in a diversified portfolio is that commodities have historically proven to be a reliable hedge against inflation. Historically, commodities, and in particular gold, have demonstrated a high inflation beta and may provide a suitable inflation hedge.

Even though the trajectory of real asset inflation is likely lower due to structural changes in demographics, technology, consumption, and productivity, starting from a low inflation level means even a small increase in inflationary pressure may lead to notable asset repricing.

Countries are embracing the renewable energy revolution, which unavoidably puts pressure on fossil fuels. On the other hand, this energy transition requires hefty investment to create the necessary infrastructure for smart grids, energy storage, and lithium-ion batteries. So, all in all, how does the ongoing energy transition affect commodity prices?

There will be obvious winners and losers in the energy transition across assets and asset classes and that is certainly true for commodities. But overall the energy transition will be a commodity-heavy exercise. What is less clear is the timing and pace of the transition and what the market will look like at the end of the day.

The technology used to mitigate or reverse the effects of climate change is expected to play a vital role in the pursuit of net-zero. Besides rare earth metals, the building blocks for many of these technologies are industrial commodities such as copper, aluminum, nickel, and silver. Historically, technology has worked against commodities, either by encouraging substitution or improving productivity and thereby requiring less of a certain raw material to meet demand. But in the case of decarbonization, the opposite is true; the adoption of green technologies signals strong demand for many commodities.

Can higher commodity prices serve as an incentive to further intensify hydrocarbons’ production and therefore delay the ongoing energy transition?

Higher prices might encourage hydrocarbon production in some regions but they may also encourage the adoption of alternative energy sources by narrowing the price gap between traditional energy sources and newer energy sources that are technology-heavy and therefore have a higher per unit cost.

The energy transition will be complex and will depend heavily on technology, levels of government support, access to capital, and the strength and breadth of the global commitment to address, and if possible reverse, the impacts of climate change.

To meet global climate and energy goals, industry sectors with a heavy emission track record like the steel industry have to curb their emissions significantly. Do current prices of commodities produced with cleaner processes justify “green premiums” for metals produced with cleaner processes from a cost perspective?

Green premiums are one-way physical market participants can signal their willingness to attribute a financial value to carbon.

Energy commodities have emerged as the winner among other asset classes in 2021, as crude oil price rebounded sharply after touching a historic low of minus $37/bbl last year and for 2021 so far, they are currently up over 50%. How high crude price could impact India’s fuel demand and will price has further leg to move up?

Rising global petroleum prices have already flowed through into higher fuel prices in India which in turn risks having a cascading effect on the value of other essential goods such as food as well as limiting the purchasing power of consumers.

Given that 80% of India’s domestic oil needs are imported the current disagreements within the OPEC+ alliance will be closely watched. Any longer-term deadlock could signal the beginning of the end for the broader supply agreement and increase the risk that members independently turn on the taps which would put downward pressure on domestic fuel prices.

S&P GSCI Index has recently completed 30 years. Can you tell us about S&P GSCI Index and how it has developed over the years?

The S&P GSCI has paved the way for three decades of index innovation in the commodities market and is the most widely recognized commodities index benchmark, just as when it launched in April 1991. Its broad base and production-weighted approach offers market participants truly global commodities market beta. By including only the most liquid commodity futures and adapting to changing market dynamics via a rules-based, transparent annual reconstitution, the index is investable and replicable.

The S&P GSCI family has been expanded and enhanced over the last 30 years – ranging from the introduction of modified weight and modified weight indices, to expanding our single commodity index offering and more recently launching a series of S&P GSCI risk premia indices.