Millburn’s co-CEO and Executive Director of Trading Barry Goodman sat down recently with a group of institutional investors at Brown’s Hotel in London to discuss disruption in the commodity markets, including the spillover into other sectors and how investors may want to think about this new environment. The Q&A below was adapted from some of the discussions that resulted from that event.
Please see important disclosures appearing here.
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Commodities have been a big story over the past year or two for a range of reasons. How do you view this in light of Millburn’s 50+ years trading commodities and your 40+ years of experience in these markets?
BG: Our firm has always been a big believer in commodity investing as a diversifier, but in terms of market forces, I have never seen the factors line up in the way they are now, and never in such a global way. There are some parallels here and there in history, but really few when you think of the connected world we live in today. That is really amplifying the impact.
Of course, some of the volatility is certainly specific to recent events—like the spillover effects of the war in Ukraine and ongoing COVID-driven supply-chain disruptions—but the overall pressure on commodity markets has actually been building for years.
What are the main drivers or factors that you have seen lining up?
[BG] First, the general theme around green energy and the global push for carbon neutrality is certainly one of the main drivers.
A simple example is the Paris Agreement on climate change. Nearly 200 countries adopted it back in 2015 to try to reduce greenhouse gas emissions and keep global warming somewhere below 2%. This type of coordination is truly without precedent, and the ambitious target has potentially massive implications for the way the world will consume commodities.
It may lead to increasing demand for the raw inputs that are needed to achieve this goal. Just as one example, to get to a “net zero” emissions goal by 2050, we may need to get to 60% electric car adoption by 2030. At the moment, we are not even at 2% in the US, and globally, we are less than 5%. Getting from 5% today to 60% by 2030 will require significant effort and support from governments, corporations, and consumers. But it will also lead to more consumption of minerals. Electric vehicles require about six times the amount of minerals of conventional cars, including metals common to all cars like copper and manganese, but also those specific to EVs like lithium, cobalt, nickel, and graphite. So this demand for these metals will accelerate.
Couple this with other sustainability practices and ESG efforts—a related but even broader global effort—and the result is an underinvestment in so-called “brown” commodities. It’s hard to find financing for a project these days to drill for more oil. But the reality is we need these brown commodities to help us make the transition to green. So there is a notable disconnect between sustainability goals and practical implementation.
China is another theme that has been building for a while. China itself is undergoing a major transition as it takes its place on the global stage.
And of course, inflation makes all of this much more expensive to finance, acting as a headwind.
Add to all this the impacts of a global pandemic and, now, significant geopolitical conflict in Ukraine, each of which resulted in a terrible human toll but also disruption in supply chains for food, materials and certain commodities. Before the pandemic, most countries and corporations just took it for granted that global supply chains and so-called “just-in-time” production was the correct strategy.
And before the conflict, few of us probably realized that Russia, Ukraine and Belarus supply an average of about 20% of certain energy, metals and food to the world.
"I believe we’ll see a lot of volatility, some attempts at substitution, violent short squeezes like we saw in the LME Nickel markets, and even shifts in political and societal opinion along the way. Geopolitical risk seems to be growing, not receding. And the uncertainty around both demand and supply will remain."
Barry Goodman
co-CEO & Executive Director of TradingSo what does this mean for commodity pricing?
[BG] Because of all these forces lining up, we’ve been left with some severe imbalances in the commodity supply/demand equation, and as a result an increased fragility of the entire system—this can mean heightened sensitivity to shocks. And again, this is playing out globally, not just in certain regions.
Already, we’ve seen moves in commodity markets that can only be described as extreme. Much of it has been to the upside, and I believe that we may be seeing just the first leg-up in pricing. Competition will intensify for the procurement of strategic metals. New, more localized alignments will form, with the resource “haves” aligning with the resource “have-nots.”
But setting up more robust supply chains takes time, and also requires additional investment in raw materials in many cases. So, the driving forces are simply too strong for the markets to ignore.
We are setting up for, in my view, a multi-year or even potentially a multi-decade cycle of upward pressure on commodity prices, depending on how things play out.
But that doesn’t mean that the ride-up will be smooth. Because the markets are so fragile at the moment, I believe we’ll see a lot of volatility, some attempts at substitution, violent short squeezes like we saw in the LME Nickel markets, and even shifts in political and societal opinion along the way. Geopolitical risk seems to be growing, not receding. And the uncertainty around both demand and supply will remain. All this could mean some large periodic corrections in commodity markets along the way, which we think points to the need for an active, tactical approach rather than a passive one.
Given the scale of some of these market themes, will there be spillover to other asset classes?
[BG] There will certainly be ripple effects across a range of different asset classes—we are already seeing it. And there will also be a whole range of other drivers that maybe aren’t so directly related to commodities but will nonetheless act to amplify the impact on those other asset classes.
But at the highest level, the movement towards de-globalization and the acceleration of sustainability adoption will impact practically all asset classes and create a range of different opportunities beyond commodities. We expect to see global capital reposition itself to take advantage of both short- and long-term opportunity sets.
In currency markets, for example, the effects are likely to be pretty clear. De-globalization, demographic shifts and fear of weaponizing the dollar will lead to new currency and trade blocs, alternative payment systems (like CIPS as a replacement for SWIFT), and more impetus for currency digitization. The dominance of the US dollar as a reserve currency, which has already been steadily eroding, is likely to continue to fall with this new realignment of blocs, and as we see producers of strategic commodities demanding payment in specific (non US dollar) currencies.
So, whereas global currencies have moved pretty much in unison over the last decade or more, I’d expect to now see some pretty significant and sustained cross-border flows, which will impact exchange rates.
Will there be an impact on fixed income and equity markets?
[BG] Yes. It is already happening. In fixed income, despite a lot of focus on inflation in some of the developed world, there is actually now some pretty meaningful global rate dispersion.
There has certainly been a move towards unwinding of the COVID-19 pandemic liquidity in certain countries, coupled with inflationary pressures (in many cases correlated to the rise in commodity prices), that has led to significant rate rises. Those inflationary pressures depend a lot on reliance on food and energy, which can differ significantly by country, depending on typical diet and traditional sources of power, for example.
So we will have central banks in some countries with high inflation seeking to keep rates low, to support local growth initiatives. Other countries will see higher levels of inflation due to their reliance on specific foodstuffs that are scarce at the moment or specific energy sources that have been cut off. And in the end, decarbonization will need to be financed, so we’ll see capital seeking the lower rates.
In equities, we are seeing, and I believe we will continue to see, investment from both government and corporate sectors as these “next-gen” initiatives move ahead.
While relatively slower to the game perhaps than its Western peers, the US is now moving on some fairly large climate initiatives and funding them to the tune of many billions per year. Meanwhile, traditional “brown energy” companies like ExxonMobil are spending big to make a transition to green; ExxonMobil recently announced it will invest 15 billion dollars in carbon capture technologies, grid storage and biofuels.
All in all, McKinsey thinks “net zero” by 2050 will cost more than $250 trillion. This means massive capital flows, which I believe will lead to the emergence of new industries and, in turn, to new opportunities for investors.
What about some of the less traditional asset classes?
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[BG] The evolving space of carbon mitigation (and carbon trading) is one sort of “bridge” asset class that is likely to see significant development. There’s been some false starts in this area over the years, but with better transparency and with China coming on board, there are opportunities here.
I mentioned the Paris Agreement earlier—the carbon markets could play an important role here as governments and financial engineers determine the best pricing transparency and off-take mechanisms to accomplish goals. We are seeing some interesting solutions that leverage the blockchain sprout up already.
You mention blockchain. What are the implications for Cryptocurrencies?
[BG] I mentioned briefly before the changes we might expect in the FX markets as a whole and the general impetus towards alternate payment systems beyond the dollar. This could certainly play in the favor of cryptocurrency adoption.
But beyond this, while a lot of the specific use cases for Crypto are still to be worked out, what is clear is the sheer number of groups trying to work it out is growing substantially, and adoption by institutional players is now pretty firmly established. Some of the pillars of traditional finance, like the CME, State Street and even Fidelity are embracing the Crypto and DeFi [decentralized finance] spaces.
Again, it’s a case of prior momentum existing, but the ripple effects of commodity disruption amplifying the momentum—either in terms of speed, or scale, or both. De-globalization means the potential needs for new ways to lend money, or finance investments, whereas the dollar may have been the standard in the past. Carbon mitigation requires new ways to think about tracking, pricing and oversight in transparent ways.
For us, as traders, we see Crypto as, at the very least, an immense source of volatility and a very interesting opportunity for data-driven approaches. We’re already running our models on it and starting to incorporate it into some of our strategies.
How should investors prepare for this environment?
[BG] I like to say that yesterday can be a very good predictor of tomorrow unless you are at an inflection point…and I think that is exactly where we are.
So, how should you behave in periods of uncertainty? Putting aside investing for the moment and just thinking about life in general, when faced with uncertainty, it’s probably best to try and gather as much relevant information as possible, do your best to make good decisions based on this information, stay away from “big bets” or putting all your eggs in one basket, and, maybe most importantly, be willing to change your view as you learn more, or as the environment changes.
I think investments should be approached the same way. What we have done at Millburn is develop an investment framework that allows us to process large quantities of data in a very rigorous way, including fundamental data, quantitative price data, and other sources. We trade many markets, as many as 150 or more globally (including China), with the idea that one never knows where the opportunities may arise. And we built a framework that trades these markets frequently and can change views quickly if needed.
In a way, we’ve been preparing for this moment for 50 years. We are hoping we can help our investors navigate what could be some choppy waters over the next several years.