JPMorgan Sees New Commodity Supercycle

Late last month, JPMorgan’s Marko Kolanovic warned on a possible tail risk associated with what he described as “the low level of new investing in traditional energy, and inability to quickly change the popular investment, ideological, and geopolitical paradigms.”

The idea, essentially, was that if increased demand associated with a post-COVID global economic recovery were to collide with underinvestment in traditional energy sources at a time when sustainable energy isn’t yet ready to take the baton in terms of shouldering the world’s energy consumption needs, a crisis could be in the offing.

“It’s possible that a full-blown energy crisis of the western world could materialize,” Marko wrote, adding that while that isn’t JPMorgan’s base case, it would have the “potential to destabilize financial markets, economies, and more broadly societies.”

Read more: Marko Kolanovic Describes ‘Full-Blown Energy Crisis’ Tail Risk

In a new note out Wednesday, jointly authored by JPMorgan’s commodities research team, Kolanovic posits the beginning of a new commodity supercylce.

He described the figure (below) as an annotated guide to “the last supercycle for Oil with various specific drivers that drove the 12-year up cycle and 12-year down cycle.”

What comes next? Well, the new supercycle will “mostly be the story of a post-pandemic recovery (‘roaring 20s’), ultra-loose monetary and fiscal policies, weak USD, stronger inflation, and unintended consequences of environmental policies and their friction with physical constraints related to energy consumption and production,” JPMorgan said Wednesday.

This is, in part anyway, an extension of the thesis behind the tail risk Marko described last month.

He also said Wednesday that modern market structure will play a role. Remember: The dynamics that exacerbate directional moves on the way down do so on the way up, too.

“CTAs played [a] significant role in the 2014 oil price downturn,” JPMorgan wrote, adding that more recently, CTAs “have been adding Energy exposure [because] 12-month momentum turned positive on Oil, and going forward signals will remain solidly positive.”

If volatility settles, cross-asset quant allocations will increase and stabilize, Kolanovic said, positing that “a larger momentum impact may affect Energy equities, which is the only sector that still has a strongly negative momentum signal and is hence heavily shorted in the context of factor investing.”

Meanwhile, active investor allocations to energy have fallen to just 1.5% in 2021 from around 7% from 2010 to 2015, according the bank’s analysis of EPFR data.

The idea is that even if this just partially reverses, it could be material. “Any retracement of this decline, on a US equity fund asset base of ~$14 trillion would result in significant inflows and re-pricing,” Marko said, citing the re-opening push, rising inflation, and steeper yield curves as the impetus for active funds “to first close cyclical shorts, and then rotate from long secular growth towards value and cyclicals.”

As for retail investors, their allocation to energy is below 1%. Marko suggested Wednesday that the kind of retail fervor which recently manifested in “meme stocks,” might show up in the energy space. “Given the increased retail activity and interest in stocks that are volatile, have high short interest, are smaller in size and have thematic news/social media coverage, the sector will likely also be of interest to retail investors,” he said.

Incidentally, Bloomberg flagged huge out-of-the-money call buying this week in something called “Ring Energy.” “[It’s] an industry minnow, [but] shares have doubled in less than two weeks,” Bloomberg remarked, on the way to marveling that “September $5 calls traded hands 82,540 times, an increase of more than 31,000% in volume from Monday.”

In their Wednesday note, JPMorgan wrote that multi-asset portfolios may be at risk in a world where bonds can no longer be relied upon as reliable hedges given the low level of yields and what, anecdotally anyway, is high “tantrum” risk.

At a recent quant conference, the bank’s investors expressed palpable concern about inflation risk. Asked about possible hedging strategies, “42% of participants answered by including commodities, 32% by increasing equities, and only 26% [saw] a solution in interest rate products,” the same Wednesday piece reads, noting that “we expect these multi-asset portfolios to add commodity and commodity equity exposure to hedge inflation.”