Future of Commodity Markets: Supply Gluts, Bank Exits, and Algorithmic Trading
Book: Commodities: Markets, Performance, and Strategies
Editors: H. Kent Baker, Greg Filbeck, Jeffrey H. Harris
ISBN: 9780190656010
Chapter 28: Future of Commodity Markets and Investments (Hunter M. Holzhauer)
Holzhauer closes the edited volume with a forward-looking chapter. No equations. Lots of industry surveys and trend spotting. The opening quote from Deloitte’s Philip Hopwood sets the tone: after the supercycle, people act like commodity prices will never recover. That is as wrong as assuming they would rise forever. Cycle times are just longer now.
The commodity market is not going away. It feeds the global economy and offers portfolio diversification when it zigs while stocks zag. But the next decade looks different depending on which commodity you trade and whether you are a bank, a trading house, or a producer.
Growth and the U.S. swing
Global commodity derivatives volume rose more than 20% from 2005 to 2015. Asia Pacific drove 55% of growth. By 2015, commodity futures passed single-stock options as the most traded derivative class.
The U.S. story shifted too. Shale oil turned America from a massive refined products importer into a net exporter of about 1.2 million barrels per day by 2013. The EIA projected possible net energy exporter status by 2019 if prices cooperated. KPMG’s 2016 trader survey picked North America as the top growth region (20% of votes).
Employment data backed the optimism. Mining support, pipeline construction, oil and gas extraction, and several ag sectors ranked among America’s fastest-growing industries from 2005 to 2014. Portfolio management and investment advice tied to commodities grew too.
Excess supply is the near-term problem
China’s shift from investment-led to consumption-led growth cut global demand for infrastructure metals. Steel is the poster child. Capacity roughly doubled since 2000. OECD projected capacity rising from 2.16 to 2.36 billion tonnes by 2017 even as demand softened. Government subsidies and new mill approvals in Asia kept capacity growing.
KPMG found 70% of commodity professionals worried about low prices in 2016. Top concerns for 2017-2018: low prices (21%) and weak growth (18%). Oversupply squeezed margins and pushed traders toward riskier, more capital-intensive deals.
Changing strategies: Traders buy assets (mines, terminals, retail chains) instead of leasing them. Long-term offtake contracts called “structural shorts” lock in demand.
Steel CEOs planned cost cuts (84% vs. 69% for all commodities). They worried about taxes, energy costs, falling prices, and access to affordable capital.
Longer-term demand drivers: UN population projections hit 9.7 billion by 2050 and 11.2 billion by 2100, mostly in Africa and Asia. More people means more food, energy, and infrastructure materials.
Climate change reshuffles winners and losers. Coal faces pressure. Natural gas benefits. Fracking created new commodities (fracking sand). El Niño affects crops and energy demand. Recyclables and potable water emerge as investable themes. Citi structured a 13.5-year wind power hedge for Facebook as an example of banks going green.
Regulation and the bank exodus
Dodd-Frank, Basel III/CRD IV, MiFID II, EMIR, REMIT, and a laundry list of other rules raised compliance costs. One-third of traders expected medium impact. Smaller firms without compliance departments felt it most.
The visible result: investment banks left physical commodities. Nine of the ten largest Western bank commodity desks exited or sharply cut back by 2014. Morgan Stanley sold its oil unit to Castleton. JPMorgan sold to Mercuria. Barclays and Deutsche Bank scaled back. Commodity hedge fund assets under management fell from $50 billion in 2008 to under $10 billion by 2015. Bank commodity revenues dropped 18% in 2015 and another 25% in the first half of 2016.
Talent followed. Trading houses like Glencore, Vitol, and Trafigura hired bank refugees. Some traders spun out (TrailStone, HudsonField). Goldman, JPMorgan, and Citi remained among the top revenue earners, adapting with complex deals and bundled services.
Market maturation squeezed intermediary margins. Thermal coal trading margins fell from $3-5 per ton to $1-3 as markets became transparent. Larger players gained scale advantages. 88% of traders felt margin pressure. New performance metrics emphasizing return on total capital (debt plus equity) may discourage inventory holding and invite price spikes when supply shocks hit.
Algorithms and three scenarios
About 74% of traders in one survey said algorithmic trading affects the future. Pros use in-house code. Amateurs outsource more. Many traders still avoid algos or have not decided. Niche human expertise in emerging markets may survive where algos are thin.
Franke et al. (Oliver Wyman) outlined three futures:
- Status quo: Low prices, heavy regulation, small traders exit. Liquidity risks rise. Another Enron-style blowup would hit harder without bank backstops.
- Return to normal: Volatility and metrics revert. Big trading houses partially replace banks.
- Regulatory easing: Banks return, liquidity improves.
KPMG data leaned toward scenario two: most traders expected prices to stay low for a few years, then recover within five.
Conclusion of the chapter
Commodities stay relevant for diversification. Technology, transparency, and regulation make markets more efficient over time. But traders cannot coast on long-term trends. China-style transitions, climate policy, political risk, and tech disruption demand constant adaptation.
Holzhauer’s message is pragmatic. The grocery store of the global economy does not close. The checkout lines just move.
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