The Future of Commodity Markets Part 3: Investment Outlook

Book: Commodities: Markets, Performance, and Strategies
Editors: H. Kent Baker, Greg Filbeck, Jeffrey H. Harris
Publisher: Oxford University Press, 2018
ISBN: 9780190656010

Three Scenarios for the Future

This is Part 3 of Chapter 28 by Hunter Holzhauer, covering the outlook for commodity markets and the chapter’s conclusion. After discussing market growth, oversupply, regulation, and technology in the first two parts, this part wraps up with three possible scenarios and some practical takeaways.

Scenario 1: The Doomsday Case

The first scenario is basically a continuation of the status quo: low commodity prices and heavy regulation. This is the worst case for the industry. In this world, traders, especially smaller ones, leave the commodity market because they can find more profitable uses for their capital elsewhere.

Only 15 percent of traders surveyed by KPMG expected commodity prices to rise in 2017. More than half (51 percent) expected prices to stay at low levels for the next few years. The remaining third (34 percent) saw prices rising within two to five years.

If you combine the exodus of small traders with the ongoing bank exodus, some less profitable niches could face serious liquidity problems and rising hedging costs. The worst-case scenario within this scenario would be the sudden bankruptcy of another commodity giant, similar to Enron in 2001. When Enron collapsed, it shocked energy markets and created liquidity problems in energy niches worldwide. At that time, major energy trading banks had both the capability and the creditworthiness to step in and provide liquidity. If something similar happened now, with most banks out of commodities, the question is whether enough liquidity providers would remain to stabilize the market.

Scenario 2: Return to Normal

The second scenario assumes commodity price volatility returns to long-term averages and rating agencies adopt more trader-friendly performance metrics. Most commodity traders expect prices to increase sometime within the next five years, which supports this view.

In this world, bigger traders push out smaller ones but also step up to provide the structure and stability that large banks once offered. The market consolidates around fewer, larger players who can handle the capital requirements and regulatory burden.

Scenario 3: Regulation Eases

The third scenario involves loosened regulations and incentives for banks to return to the commodity markets. This would be the best case for market liquidity and trading activity. More intermediaries means tighter spreads, better hedging options, and deeper markets.

The Practical Takeaway

Regardless of which scenario plays out, the chapter argues that commodities are not going away. Two fundamental advantages keep them relevant:

First, diversification benefits. Commodities tend to zig when other markets zag, as Jim Rogers put it. Markowitz (1952) showed that diversification within a portfolio reduces volatility and increases expected returns. The array of correlations (and lack of correlations) between commodities and other asset classes creates an almost built-in investor demand.

Second, real economy necessity. Commodities are the inputs that make the global economy work. As long as people need energy, food, metals, and building materials, commodity markets will exist. The global population is growing. Emerging economies are developing. The demand side of the equation has a long runway.

The Long Game

The chapter is cautiously optimistic about the long term. Increased efficiency from better regulations, improved transparency from research, and enhanced technology will all contribute to more stable commodity markets over time. Technology will not only speed up trades but also create new demand for specific commodities and improve production and storage capacity, especially for volatile commodities like electricity.

But stability is not guaranteed and will not arrive quickly. China’s transition from a developing economy to a consumer-led economy explains a large portion of recent commodity market volatility. While it is hard to imagine another emerging economy having the same disruptive impact as China, large capital investments into transforming economies will remain a source of uncertainty.

And even when stability does arrive, complacency is dangerous. The rapid pace of change in investor demand, technology, and climate and political issues means traders need to keep adapting. As the chapter puts it: “In today’s commodity markets, traders need to be constantly adapting to the commodity markets of tomorrow.”

Where Specialists Will Thrive

The chapter suggests that the best traders going forward will be specialists. The days of making easy money as an intermediary are numbered as markets become more transparent and liquid. The value will shift to traders who deeply understand specific niches.

Some will work for suppliers or buyers, focusing on commodities like agricultural products from South America or crude oil derivatives in the Middle East. Others will work on complex, structured deals that algorithms cannot handle. The most adaptable traders will combine deep commodity knowledge with the ability to use technology as a tool rather than competing against it.

The chapter also highlights emerging niches. Potable water, renewable energy credits, recyclable materials, and carbon credits are all growing commodity segments driven by population growth and climate change. These markets are still developing their infrastructure and liquidity, which creates opportunities for traders willing to accept the uncertainty.

The Book’s Final Message

Holzhauer’s conclusion ties together the themes from the entire book. Commodity markets are cyclical, complex, and constantly evolving. The current challenges (oversupply, regulation, technology disruption) are real but not permanent. The fundamental drivers (global population growth, economic development, diversification demand) provide a strong foundation for the market’s long-term relevance.

The most successful participants will be those who combine creativity and flexibility with deep expertise. That combination has served commodity traders well throughout history, and it will be even more critical going forward.

My Take

I like how the three scenarios framework gives readers a structured way to think about uncertainty. Most commentary on commodity markets either predicts doom or promises a boom. The reality, as the chapter suggests, probably falls somewhere in between.

The scenario I find most likely is a modified version of Scenario 2. Prices will recover eventually because they always do in cyclical markets. But the market structure will look different. Fewer banks. Bigger trading houses. More algorithmic execution. More regulation. And a growing number of new commodity classes (water, carbon, renewables) that did not exist a generation ago.

The Enron thought experiment in Scenario 1 is worth taking seriously. If a major commodity firm collapsed today, the market’s ability to absorb the shock would be genuinely tested. That alone is a strong argument for maintaining some bank involvement in commodity markets, even if the business is not as profitable as it once was.

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