This year, the demand for new energy vehicles such as NIO Inc., Tesla, Inc., BYD and Hongguang MINI EV has soared. But what else can we invest in other than new energy stocks?

Commodities, especially industrial metals, have ushered in a rising cycle since the second quarter, driven by a better-than-expected rebound in the Chinese economy and an explosion of demand for new energy vehicles in China and Europe.

As an ordinary investor, how to seize the investment opportunities?

Strong return of commodities

Since the second quarter of 2020, with the gradual stabilization of the domestic economy, commodity markets have ushered in a strong rebound. In terms of South China Commodity Composite yields, commodities rose 17.8 per cent from April 1 to October 22, 2020, better than 9.2 per cent and 0.3 per cent in 2019 and 2018.

According to the sub-index, the performance of industrial metals and precious metals is stronger.

Figure 1: performance of commodities and sub-indices

Figure 2: yield of industrial metals + thermal coal (%)

The reasons for the strength of Industrial Metals

(1) China's economy rebounded faster than expected

After the outbreak of the epidemic in 2020, countries generally adopted strict control measures, and the global economy quickly fell into recession.

Thanks to effective epidemic prevention and control measures and loose policy support, China's economic recovery is ahead of other countries, leading to a sharp rebound in industrial metal prices.

The reason for this is that, on the one hand, after the relaxation of epidemic control measures, the resumption of work in the secondary industry is faster than that in the tertiary industry; on the other hand, investment is more sensitive to lower interest rates and fiscal expansion than consumption (real estate is the most sensitive to falling interest rates under loose monetary policy, while the main source of funding for infrastructure is fiscal bond issuance).

Based on this, we can see that since the second quarter, the main driver of China's economic recovery is the better-than-expected recovery in real estate investment, infrastructure and industrial production.

The recovery of real estate, infrastructure and industrial production is highly dependent on industrial metals. After the epidemic, with the gradual acceleration of recovery in the three major areas, the demand for industrial metals continued to rise, which finally pushed up the rebound in industrial metal prices.

(2) flooding of global liquidity

In addition to the China factor, loose global liquidity also played an important role in supporting industrial prices during the year. Commodities have both physical and financial characteristics, so commodities have better anti-inflation properties than other investments.

During the year, the developed economies represented by the Federal Reserve generally launched a super-loose monetary policy, resulting in a flood of liquidity around the world. On the one hand, the expansion of liquidity can better support the economy to hit bottom and rebound, on the other hand, it is also easy to trigger the later upward level of inflation.

The flood of liquidity in global markets, particularly in the US, has raised investor expectations for future inflation, partly triggering anti-inflationary demand for commodities and supporting the rise in commodity prices.

Figure 3: rapid decline in global short-end interest rates

Figure 4: the relationship between US inflation and commodities

Prospects for the future

Looking forward to the fourth quarter, we remain bullish on investment opportunities related to commodities, especially industrial metals. The specific reasons can be summarized as follows:

(1) Resonance of Sino-US economic recovery

Since the second quarter, China's economy has taken the lead in recovering, and after August, the degree of economic recovery has accelerated significantly. As shown in figure 5, according to the output gap index of Caixin Securities (measured by industrial value added), the current economic cycle actually began in October 2019, but the economy experienced a brief recession due to the impact of the epidemic at the beginning of the year. After the impact of the epidemic bottomed out in April, China's economy returned to the recovery cycle in May, and the recovery process accelerated in August.

Combined with the inventory cycle, the inventory cycle entered the passive de-inventory stage in May, and the inventory inflection point appeared in August, indicating that the domestic inventory cycle may be in the channel of "passive de-inventory-active replenishment".

On the whole, China's inventory cycle is in good agreement with the industrial output gap, indicating that after the fourth quarter, China's economy is expected to transition from the recovery stage to the expansion stage.

Figure 5: industrial production output gap

Figure 6: inventory cycle in China

Compared with the strong performance of our economy, the overall recovery of the US economy during the year was weak. As figure 7 shows, the US economy fell into recession in February 2020, ending the cycle of expansion since June 2009. After May, with the recovery of demand, the inventory cycle in the United States entered the passive destocking stage of price increase and volume contraction.

But since June, a second outbreak has extended this round of passive destocking. Looking ahead, it is expected that with the conclusion of the November election, the United States is expected to introduce more stimulus policies to accelerate the recovery of demand, so that US inventories are expected to bottom out between the end of the fourth quarter and early next year.

Figure 7: us inventory cycle

Taken together, starting from the fourth quarter, the strong recovery of China's economy superimposed the resonance of the recovery of the US economy, which is expected to lead to a further release of demand for industrial metals and drive industrial metal prices to continue to rise.

（2) the demand for new energy vehicles is soaring.

According to Goldman Sachs Group, a relatively alternative reason for the rise in industrial metal prices during the year is the rapid promotion of new energy-related policies in China and Europe.

In Europe, in 2020, the European Commission issued the strictest carbon emission regulations in history, while 24 of the 27 EU countries have introduced incentives for new energy vehicles. Driven by policy, the European new energy vehicle market expanded rapidly, surpassing China to become the world's largest new energy vehicle market in the first half of the year.

According to the European Automobile Manufacturers Union (AECA), sales of new energy vehicles in Germany, the UK, France, Norway, Sweden, Portugal, Italy, Switzerland and Spain totaled about 133000 in September 2020, up 195 per cent from a year earlier. However, at present, the permeability of new energy vehicles remains at a low level of 12%.

Domestically, with the recovery of China's optional consumption in July and August, China's automobile consumption rebounded rapidly, supporting the stability of the whole consumption level.

In September 2020, China sold 138000 new energy vehicles, an increase of 67.7 percent over the same period last year, setting a new record for September, and wholesale sales of new energy passenger vehicles exceeded 125000 in September, up 99.6 percent from the same period last year, according to the passenger Associated Press.

What is more gratifying is that this round of sales surge is based on the decline of subsidies, showing a strong rebound in C-end demand.

Looking ahead, it is expected that with the continuous expansion of new energy market demand in China and Europe, industrial metals such as copper, which are closely related to new energy manufacturing, still have a lot of room to rise.

In addition, if Biden can be successfully elected in the future, the United States is expected to launch a corresponding "green infrastructure" policy, which is expected to further push up the price increase of industrial metals.

Configuration recommendation

In the financial market, direct investment in commodities belongs to futures investment and has a high leverage attribute. The behavior of adding leverage will magnify the volatility of commodities and make investors bear more risks, which is extremely unfriendly to ordinary investors.

Therefore, for ordinary investors who want to participate in this commodity cycle, rather than investing directly in commodity futures, 36Kr Holdings analysts suggest that everyone focus on the pro-cyclical raw materials sectors that are more related to industrial products, such as steel, cement, coal, etc., as well as the upstream raw material sectors in the new energy vehicle industry chain, such as non-ferrous metals (copper, aluminum, lithium, cobalt), etc.