Commodity prices are at risk of a major reversal that could whipsaw investors positioning for rising inflation, Societe Generale says

• Commodity prices are at a high risk of a major reversal, according to Societe Generale's Albert Edwards.
• Edwards noted that a Chinese data point that typically drives commodity prices just saw a steep downturn.
• When prices fall, Edwards expects a "major reversal in inflation sentiment."

Commodity prices are at a high risk of a major reversal, according to Societe Generale's Albert Edwards.

The firm's global strategist said in a Wednesday note that despite the euphoric optimism about the strength of the global economic cycle and its inflationary implications, investors may be in for a major cyclical shock relative to expectations.

He sees commodity prices at a risk of a reversal because of the steep downturn in the Chinese Credit Impulse. The credit impulse measures the change in new credit issued as a percentage of GDP, and it's historically been viewed as a driver of commodity prices.

"While so many investors are focused on President Biden's super-loose (some would say crazily loose) fiscal stance in the US, they are missing the deflationary impulse heading down the tracks from China," Edwards added.

Fears of overheating inflation have been at the center of investor concerns in recent weeks, even as US central bank officials signal that pricing pressures will be transitory.

Investors typically view commodities as a hedge against inflation, but Edwards noted a saying from investor George Soros that there's an odd "reflexivity" to investors' belief in rising inflation that could actually be driving prices of everything higher.

When investors pile into commodities for inflation protection, they actually create upstream cost pressures (as highlighted by PMI corporate surveys), Edwards said. Those cost pressures bring on a "cascading effect" of upstream commodity price pressures, and headline CPIs are quickly impacted as food and energy prices rip higher, he added.

In turn, as investors observe industrial commodity prices rising, their beliefs that inflation also on the rise are reaffirmed.

"The circular, or as George Soros terms it, 'reflexive' nature of financial markets makes them extremely vulnerable to being whipsawed. Yet because of the current extreme momentum it would take a very heavy weight of evidence to convince this market to reverse direction," said Edwards.

He added: "When commodity prices do start to fall, expect a major reversal in inflation sentiment. And expect momentum to become as self-reinforcing and reflexive on the way down just as it was on the way up!"