Summary List Placement
Commodity trades have paid off for UBS this year.
In an April 5 research note, UBS’s wealth management division highlighted that energy was up 22% while livestock was up 14%, both of which were commodity sectors that the division positively recommended at the start of the year.
Despite commodities having already had a good run, UBS isn’t ready to cash in and check out just yet.
The division still remains bullish, outlining the case for certain commodities to run higher in the recent note.
“Although prices are firmly up this year, we see another 10%–15% upside for the overall asset class over the next 6–12 months,” said UBS strategist, Dominic Schnider.
The bull case
UBS’s bull case is driven by two core components:
1) Global economic growth
UBS economists expect global economic growth to move strongly above trend from the second quarter of 2021 onwards.
“While near-term COVID-19 challenges remain, we now expect global economic activity to accelerate by a seasonally adjusted annual rate (SAAR) of around 7.4% q/q in 2Q21 and to stay above 6% — well above trend — until the year-end,” Schnider said.
2) Global mobility
As the vaccination rollout gathers pace, this will create a backdrop for market tightness across energy and base metals, the strategists said.
“Improved pricing power on the supply side, as well as the need for demand rationing in some commodities, should allow prices to overshoot,” Schnider said.
The proposed $2.25 trillion infrastructure package from President Joe Biden could also drive demand higher for natural resources over the long term.
The strategists highlight that around $1.3 trillion is allocated for highly commodity-intensive areas, such as housing, highways, transit, grid modernization and energy storage.
“A step up in US commodity consumption would be particularly supportive, such as for copper or steel, at a time when consumption in the rest of the world is accelerating and structural demand forces are at work due to decarbonization efforts,” Schnider said. “This would help to further tighten market balances across cyclical commodities.”
Not all sectors are created equal….
UBS strategists are more bullish on certain sectors than others.
“But as we’ve seen so far this year, not all sectors are likely to perform well,” Schnider said.
They believe the backdrop is most supportive for energy and base metal prices, pointing to a 15%-20% upside over the next six to 12 months.
“We estimate energy-oriented investors are likely to enjoy an additional 2-3 percentage points or more of roll gains until the year-end, as the futures curves for crude oil and oil products are downward sloped (i.e., in backwardation),” Schnider said.
There will also be “residual price strength” in agriculture and a stabilization in livestock prices, the strategists said as well as a pull back in precious metal prices.
“We advise investors to be long crude oil and base metals overall, to protect gold holdings against downside price risks, and to shift into precious metals with a strong industrial demand footprint,” Schnider said. “We prefer broad agriculture exposure and see upside risks for livestock.”
On the other hand, Schnider expects gold and silver to struggle amid higher real interest rate expectations in the US.
We break down UBS’s eight commodity trade recommendations based on this outlook.
1. Long agricultural commodities
Target return over three months: 10%
Analyst commentary: “We shift agricultural commodities to Most Preferred and favor second-generation indices. Although prices rose sharply in 1Q21, we believe price risks remain skewed to the upside in corn and soybean, particularly into midyear. With weather uncertainties persisting in Brazilian corn and US spring row crop planting, any missteps would be bullish signals for prices given the tight fundamentals. Likewise, we are optimistic on softs like sugar, coffee and cotton. Vaccination progress and related reopening should support demand for certain processed products, while Arabica coffee supply looks constrained into 2H. Downward-slopping forward curves could help investment performance as well.”
2. Long Brent crude oil
Target price: $75 a barrel
Stop-loss: $50 a barrel
Analyst commentary: “With the vaccination process expected to gain pace and OPEC+ likely to keep to a cautious approach—reducing production cuts when demand recovers—we expect oil inventories to normalize by mid-year, which should support prices. We remain long Brent—a trade we initiated on 6 January—targeting a move to USD 75/bbl.”
3. Long palladium
Target price: $2,900 per oz
Stop-loss: $2,100 per oz
Analyst commentary: “Given that palladium is likely to be in deficit for the tenth straight year in 2021, and given above-ground inventories are at their lowest levels since 2003, we expect this tightness to translate into higher prices in 2021. With the global economy expected to recover strongly this year, rising industrial demand along with recovering car production and sales (the metal is used in catalytic converts of gasoline cars) will likely further support prices in the months ahead.”
4. Long Brent crude oil through exposure to long-term futures contracts
Analyst commentary: “Thematically, we advise investors to gain exposure to longer dated oil contracts. By doing so, investors can lock in the discount of longer-dated futures contracts versus current spot prices. Futures contracts expiring in mid-2022 are currently trading at about a 10% discount to the spot price. We expect these contracts to converge at expiry to our Brent crude oil forecast of USD 75/bbl.”
5. Long base metals
Target return: 15%
Analyst commentary: “We advise investors with a strong risk appetite to target a 15% rise in base metal prices from current levels. A sharp move up in global growth should tighten market balances across the sector, particularly in copper, and allow prices to continue moving up. Given the sector has already rallied over the last 12 months, investors are strongly advised to place stop-losses. In the case of broad sector exposure, we would set the stop-loss at –7.5%. The targeted investment tenor is 6–12 months. We prefer to engage via strategies that can mimic the CMCI industrial metal index.”
6. Yield pick-up strategy for Brent crude oil
Target return: 8%
Analyst commentary: “While option volatility in crude oil has normalized to levels slightly above 30%, we think the downward-sloped futures curve and our outlook for higher prices speak in favor of strategies that sell the downside risks in crude oil prices for yield. We like strike levels at USD 55/bbl and target a tenor of six months. Such strategies should come with the possibility to hold direct exposure to crude oil. If prices drop sharply versus our expectations, we would advise investors to go outright long crude oil and target a price reversal to the initial strike level.”
7. Yield pick-up strategy in platinum group metals
Target return: 4% and 7%
Analyst commentary: “Improving economic activity and the supply disruptions in Russia should ensure that palladium and platinum are undersupplied this year. We favor strike levels at or Commodity markets 07 below USD 1,075/oz for platinum and USD 2,300/oz, for palladium, and target a yield of 4% and 7% p.a.”
8. Yield pick-up strategy in base metals
Target return: 8% to 9%
Analyst commentary: “Given our positive price outlook and higher option volatility, particularly in copper, we continue to advocate for selling volatility (downside risks) in copper, lead and nickel. Investment tenors of six months are preferred in order to take advantage of the global economic growth acceleration. Strike levels should be set at USD 8,100/mt for copper, USD 1,875/mt for lead and USD 14,750/mt or lower for nickel. Investors should target yields of at least 8% p.a. for copper and lead and 9% for nickel. In case prices trade below the strike level, we advise investors to target the initial strike levels by going long the underlying.”