Midyear Commodity Outlook: Are Higher Rates Masking Tight Inventories?

Commodity markets have enjoyed a solid rally to start the year after a disappointing finish to 2023. The Bloomberg Commodity Index, a widely recognized proxy for the asset class, rose nearly 7% through the end of May, lifted by strength across nearly all segments except grains.

As we move into the second half of 2024, let’s take a look at a familiar market dynamic that’s often misunderstood in commodity investing: Current inventory levels may be much tighter than futures curves are signaling. Historically, tight inventories have often been associated with better performance for the asset class—but also greater volatility.

Surplus pricing illusion

Back in the summer of 2022, we observed a confluence of supply-side constraints brought on by the pandemic and Russia’s invasion of Ukraine, which sent raw material prices to new records. Simultaneously, this environment pushed commodity futures markets significantly into backwardation—a phenomenon where spot prices trade at a substantial premium to futures prices. The opposite state is referred to as contango, where spot prices trade below futures prices.1

Today, these effects seem to have dissipated. Commodity markets overall appear to be trading with a slight degree of contango. As of May 31, the average level was roughly -0.4%.

A market in contango would suggest that near-term supplies of a commodity are sufficient to meet current demand. Contango is typically observed during periods of surplus inventory in physical raw materials and often unfairly carries a negative connotation related to investment prospects of the asset class.