Commodities could continue their comeback in second half even if equities falter. How to play it

Published Tue, Jun 30 202012:48 PM EDT

(This story is for CNBC PRO subscribers only.) The blistering comeback in commodity prices — specifically copper and oil — suggests that as manufacturing activity picks up, driven by businesses reopening as well as continued support from fiscal and monetary policy, the global economy is rebounding. And Wall Street strategists, who are tepid at best on equities for the rest of the year, say that with global growth set to continue rising, now's the time for investors to increase their commodity allocation. "[Oil's] recent rally, taken with the co-movement of metals prices, suggests the global economy is bouncing back after a sharp fall off during Q1 and the early part of Q2," MKM Partners' Michael Darda wrote in a recent note to clients. "Copper is attempting to break out, which will be bullish for the overall economy," he added. On Tuesday copper hit its highest level since January, trading above $6,000 per ton on the London Metal Exchange, and is on track to register its third straight month of gains after climbing nearly 30% from its March 23 low around $4,617 per ton. The metal is also on track for its best quarter in nearly a decade after rallying more than 20%. West Texas Intermediate crude's rally has been even more extreme. After plunging into negative territory in April for the first time on record, the benchmark now trades around $38 per barrel, and is on track for its best quarter in nearly three decades. Each is still below its 2020 high — copper's at $6,300 per ton, WTI at $65.65 — but analysts point to the demand jump as indication that the global economy is recovering from the pandemic-induced recession faster than expected. Manufacturing picks up The key driver of the price recovery has been businesses around the world getting back up and running. This is especially true of China. As the world's largest consumer of copper, and second largest importer of oil, the nation's industrial activity has a significant impact on the global commodities trade. In May, manufacturing activity in China unexpectedly expanded , with the Caixin/Markit Manufacturing Purchasing Manager's Index coming in at 50.7. PMI readings above 50 indicate expansion, while those below that level signal contraction. The number was stronger than the 49.6 print economies polled by Reuters had been expecting, and it also represented a return to expansion following April's reading of 49.4 "Chinese metals demand from construction and infrastructure has exceeded even the most optimistic projections," summed up Goldman Sachs analysts in a recent note. Cailin Birch, global economist at the Economist Intelligence Unit, believes China's GDP will grow by 1.4% in 2020, offering continue support for copper prices. "This is modest growth, by China's standards, but still a much better performance than all other major economies," she said. "The resumption of industrial production in China in recent months, while still below pre-coronavirus levels, has therefore lifted the industrial metals market." While the U.S. and Europe are behind China in terms of recovery given that lockdown restrictions went into effect around March, compared with China's January shutdown, manufacturing is also starting to pick up. In the euro zone, flash PMI data for June came in at 47.5 , compared with Street estimates of 42.4, according to Reuters. The number also marked a significant jump from May's final reading of 31.9. Meanwhile in the U.S., while manufacturing activity did continue to contract in May, it bounced from April's reading, which was an 11-year low . Additionally, U.S. retail sales surged 17.7% in May, the biggest monthly jump ever. And while data released Thursday showed a 14th straight week of first time jobless claims topping 1 million, it was also the first time in two months that the number of people receiving unemployment benefits dropped below 20 million. A rising number of Covid-19 cases in the U.S. has stoked fears in the market, but disruptions in Chile's mining activity means that a demand shortage could drive copper prices higher even if the rebound in manufacturing activity cools. Chile's Minister of Mining said Friday that output in the world's largest copper producer is expected to fall by 3.5% as the coronavirus pandemic halts operations, according to Reuters . More gains ahead? With industrial activity expected to continue picking up, strategists are becoming increasingly bullish on commodities. "We remain constructive on copper into year-end and see scope for the red metal to rise to $6,500/t," Bank of America said in a recent note to clients. "Copper is our commodity strategists' top pick over the next 6-12 months, with prices expected to lift 11% by early 2021 amid stimulus measures, ongoing supply disruption and low inventories," added Morgan Stanley. For investors looking to get in on the trade, Morgan Stanley's top picks among the miners are Glencore , First Quantum Minerals , KAZ Minerals and Lundin Mining Corporation . Copper-focused ETFs include the United States Copper Index Fund , as well as the Global X Copper Miners ETF , both of which are up sharply over the last quarter, but still in the red for the year. Copper is considered by many to be a barometer for the health of the global economy given its end-use in a vast array of consumer products. During downturns copper prices typically tumble as construction grinds to a halt and consumers stop spending. On the flip side, during economic booms demand rises. Like copper, oil's price is also closely linked to the macro backdrop. Prices have rebounded as business has picked up and consumers have begun to travel again. UBS recently lifted its 2020 Brent forecast to $42.25 per barrel, noting the "faster-than-expected recovery." "A key surprise in 2Q was how fast US production fell," the firm added. Bank of America also raised its oil forecasts, and now sees WTI averaging $39.70 per barrel for the year, with Brent averaging $43.70 per barrel. There are many options for investors who want to bet on further upside for oil prices. The Energy Select Sector SPDR Fund tracks the largest players in the U.S. oil and gas industry, and all of the components have exposure to oil prices. For investors looking for something more closely tied to the price of the commodity itself, the United States Oil Fund is comprised of future-dated contracts. The fund is down more than 70% this year, however, and has undergone a series of changes to its mandate since the oil market was rocked by WTI's plunge into negative territory in April. While the fund used to focus on the front-month contract, it now holds a broader mix of longer-dated WTI contracts . Unlike the copper market, however, the oil market also has to grapple with the supply overhang caused by more than a billion people around the world staying home in an effort to slow the spread of Covid-19. The market has begun to rebalance after record production cuts from OPEC and its-oil producing allies as well as the U.S., Canada and Norway, among others, and WTI is on track for its best quarter in thirty years. That said, some, including Miller Tabak's chief market strategist Matt Maley, aren't as optimistic on copper and oil looking forward. He said that while the surge in prices does show that the global economy is bouncing, this was to be expected once countries began easing lockdown measures. "We also have to consider that the weaker dollar is helping these two commodities, so I'm not so sure we can assume we'll get back to the pre-pandemic [price] levels in the economy quickly," he said. "More importantly, even though these commodities have retraced a lot of the losses they experienced in Q1, they are still well below their 2018 highs." Safe haven assets rise At the same time, investors are also piling into safe-haven trades amid fears over a second wave of coronavirus cases. Gold rose to its highest level since 2011 on Tuesday, and is on track for its best quarter since 2016, and its seventh straight quarter of gains. On Friday, U.S. government debt yields dropped to record lows after Florida and Texas announced rollbacks in their reopening plans. "Much of the recent economic data has been better than expected, but we still expect the recovery to potentially take years to get back to some previous levels of output," said LPL Financial's Ryan Detrick. - CNBC's Michael Bloom contributed reporting.

Employees work to make ventilators as U.S. Vice President Mike Pence visits the General Motors Components Holding Plant that is manufacturing ventilators for use during the coronavirus disease (COVID-19) outbreak, in Kokomo, Indiana, April 30, 2020.

Chris Bergin | Reuters

(This story is for CNBC PRO subscribers only.)

The blistering comeback in commodity prices — specifically copper and oil — suggests that as manufacturing activity picks up, driven by businesses reopening as well as continued support from fiscal and monetary policy, the global economy is rebounding.

And Wall Street strategists, who are tepid at best on equities for the rest of the year, say that with global growth set to continue rising, now's the time for investors to increase their commodity allocation.

"[Oil's] recent rally, taken with the co-movement of metals prices, suggests the global economy is bouncing back after a sharp fall off during Q1 and the early part of Q2," MKM Partners' Michael Darda wrote in a recent note to clients. "Copper is attempting to break out, which will be bullish for the overall economy," he added.