Do the rally in metals, other commodities, hint at reflation trade?

Investors turn overweight on sectors or assets that will gain from rising inflation, such as commodities, cyclical stocks or securities that are protected from inflation.

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Metals, other commodities soaring

Gold and silver prices have been rising in tandem to touch their lifetime highs on safe-haven demand amid heightened geopolitical tension in the Middle East. The rise in the precious metals despite pressure from a stronger dollar and firming US Treasury 10-year bond yields. Brent crude prices are hovering around $90 a barrel, as concerns regarding supply emerge.

Metal stocks have been rallying on the domestic front, with the Nifty Metal index surging 60 percent over the past year, surpassing the 30 percent gain seen in the Nifty 50 index during the same period.

Aluminium prices have been trading around 22-month highs, while nickel prices are touching seven-month highs following US and British bans from the London Metal Exchange and CME from accepting new Russian production.

In March, China's manufacturing activity expanded for the first time in six months, rising at the fastest pace in 13 months. The manufacturing purchasing managers' index rose to 50.8 in March from 49.1 in February, which experts see as a sign of stabilising of the world's second largest economy.

Are there signs of reflation trade?

The reflation trade is on again, with some of it already playing out, said Madhavi Arora, lead economist at Emkay Global Financial Services. She pointed to the waning hopes of seeing monetary policy easing from the US Federal Reserve.

“A higher inflationary impulse in the coming years may not be ruled out. Some structural asset allocation to inflation resilience makes sense,” she said. However, according to some analysts, it might be too premature to call the ongoing commodity and metal rally a result of reflation trade.

In a conversation with Moneycontrol, Hitesh Jain, strategist at Yes Securities said, “Obviously, reflation is there. However, when you look at the on-going rally in commodities, you can see it is entirely supply-driven. When compared to commodity rallies in the past, it was always driven by a demand narrative.”

A supply-driven commodity rally occurs when disruptions in the supply chain lead to price hikes. On the other hand, a demand-driven rally occurs when increased demand for the commodity pushes prices higher. Both forms of the rally push commodity prices higher, but the underlying dynamics differ, based on which the sustainability of the rally also varies.

Offering a contrary opinion, Bhavik Patel, senior commodities analyst at Tradebulls Securities, said, “The rally in commodities is not on account of reflation - it is more a function of speculative exuberance rather than an economic resurgence.” The recent crisis between Israel and Palestine has played out positively for gold and crude prices.

Drawing comparison to the recent strength seen in the domestic equity benchmarks, Patel said that the fear of missing out (FOMO) has caused investors to shift focus from the stock market frenzy to a frenzy around commodities.

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