By Joseph Moss, International Banker
While most markets experienced sizeable losses in 2022, the commodities market stood out as one of the rare exceptions, extending the gains it experienced in 2021 and marking two straight years as the best-performing major asset class. While the S&P 500 lost more than 18 percent over the past 12 months, for instance, the iShares S&P GSCI Commodity-Indexed Trust, which tracks the performance of the S&P GSCI Total Return Index of highly liquid and diversified commodities futures contracts, rallied by more than 24 percent.
Underpinning much of the strength across the commodities complex this year has been the continuation of hostilities in Ukraine, with Western sanctions imposed on Russia having the most significant impacts across several key markets, particularly energy markets such as oil and gas and agricultural commodities such as wheat. This was initially felt through mounting supply concerns, with Russia responding to Western sanctions by cutting supplies to the European Union (EU) and other countries it deemed as “unfriendly”, although much of this potentially forgone supply was seemingly absorbed by China and India. But as inflation accelerated throughout the year, those concerns shifted towards demand uncertainty as central banks virtually across the world hiked interest rates repeatedly to contain runaway prices.
The prolonged implementation of Beijing’s strict zero-COVID policy to contain a major outbreak of the virus also played a strong role in curtailing consumer confidence throughout much of 2022. Coupled with the global monetary tightening, therefore, the marked cooling of global demand, particularly during the latter half of the year, meant that stellar gains across various commodities that had been registered during the first and second quarters were pared back considerably during the final few months. And with no end to the Ukraine conflict in sight and interest rates expected to continue rising at least during the first quarter of the year, both supply and demand risks remain elevated into early 2023.
As such, the outlook for commodities in 2023 is one of opposing forces. Will prices rise as Russia continues to curtail supply to key commodity consumers, or will the global economic slowdown brought about by higher borrowing costs have the final say and weigh on consumer sentiments? And perhaps most importantly of all, could the ongoing reopening of China prove to be the pivotal factor in keeping commodities prices elevated?
At this stage, the consensus among analysts is that commodities will experience a modest decline in 2023 compared to last year. For instance, although J.P. Morgan throughout the year raised its Brent crude-oil price projections for 2022 from an average of $90 per barrel (/bbl) at the start of the year to $104/bbl and then $98/bbl for 2023, it has since lowered those forecasts. “After maintaining our price view for eight months, we now opt to shave $8 off our 2023 price projections, on our expectations that Russian production will fully normalize to pre-war levels by mid-2023,” Natasha Kaneva, head of the Global Commodities Strategy division, noted in the US bank’s Commodities Outlook section of its “2023 Market Outlook” report. “Despite more pessimistic expectations for balances over the next few months, we find the underlying trends in the oil market supportive and expect global Brent benchmark price to average $90/bbl in 2023 and $98/bbl in 2024.”
What is the main reason for J.P. Morgan’s more bearish view? The unfavourable monetary environment, it would seem. According to the 31 countries tracked by J.P. Morgan Research, 28 have raised their interest rates, with the US bank suggesting more hikes will likely come. “Based on its current guidance, the Federal Reserve will have delivered a cumulative adjustment of close to 500 basis points on rates through the first quarter of 2023,” the bank noted in its “2023 Market Outlook: Stocks Set to Fall Near-Term as Economic Growth Slows”, although it added that a degree of uncertainty is clouding the outlook for the coming year as the U.S. Federal Reserve (the Fed), primarily, and other major central banks will likely pause interest-rate hikes by the end of the first quarter of 2023.
As such, the increasingly subdued global economic environment is being touted by most analysts as the key factor triggering a moderate easing across the commodities complex vis-à-vis 2022, although most markets will continue to enjoy elevated prices when compared with previous years. Of the 26 key commodities analysed by Fitch Ratings for its “2023 Outlook”, for example, the rating agency marked 19 (or 73 percent) as expected to average lower in terms of market price on a year-over-year basis. “Most notably, we see tin, palm oil, coking coal, lithium, cotton, iron ore, thermal coal and coffee averaging sharply lower; while we expect sugar, rice, cocoa, lead and gold averaging higher,” Fitch noted, adding, however, that 16 of the 26 markets will average levels higher in 2023 than those observed in early December.
The world’s largest consumer of most commodities, China, is almost certain to play a key role in determining how the space will ultimately perform this year. With its gargantuan economy effectively shuttered for much of last year amid serious concerns over potentially disastrous COVID outbreaks, the relaxation of lockdown restrictions in recent weeks and further easing expected this year should represent a significant injection of demand for global commodities that was largely absent during much of 2022. “China’s COVID policy is the most important fundamental factor for global demand in commodities and energy in 2023, as its demand softness due to lockdowns in 2022 was a key safety valve for oil, gas, and coal markets, while Europe scrambled to replace Russian energy,” Dan Klein, head of Future Energy Pathways at S&P Global Commodity Insights, noted in the firm’s December “Energy Outlook 2023”, which estimated that China’s total energy demand would increase by 3.3 million barrels of oil equivalent per day, up from a virtually flat growth last year. “With another year of vaccinations and growing frustrations with lockdowns domestically in China, restrictions will likely ease somewhat in 2023 and imports of fossil fuels can be expected to increase again.”
Fitch, meanwhile, sees the Chinese economy growing from 3.6 percent in 2022 to 5 percent in 2023. “While the government’s Zero-Covid policy and the weak property sector pose downside risks to these forecasts, Beijing has provided significant policy support in recent months including a slight easing of Covid-19 restrictions as well as a 16-point plan to support the real estate sector,” the rating agency noted in its December commodities outlook for 2023.
Not all analysts anticipate a decline this year, however, with Goldman Sachs being perhaps the most bullish among the major forecasters about the space. Indeed, Goldman has stated that commodity markets are in the middle of a supercycle that began in October 2020 and believes this coming year will be more bullish for most commodities than it has been at any point since then. The bank largely attributes this bright outlook to the lack of short-run capital expenditure across the complex that is preventing sufficient spare capacity and China’s economic recovery that is keeping prices elevated to such a degree that market performance will eclipse 2021’s startling gains of 42 percent.
“While investors remain concerned with the 2023 growth outlook—a large driver of the latest sell-off—the global business cycle is far from over,” the bank asserted in its “2023 Commodities Outlook: An Underinvested Supercycle”. “Our economists argue that global economic growth is set to rebound with China seeing the reopening happening today, Europe improving its energy efficiency in a one-off decline in industrial activity and a slowing of the aggressive Fed rate hikes in the US. These underpin our expectation that commodities (S&P GSCI TR) will return 43 percent in 2023.”
Should Goldman’s bright expectations come true, gold and other precious metals will likely play a significant role in delivering positive returns for the commodities complex. Gold prices have steadily risen since November as investors seek safe-haven assets to protect their wealth amid deteriorating market conditions and the growing likelihood of prolonged recessions in the United States and Europe. Central banks, in particular, have shown interest in expanding their exposures to the yellow metal in recent months. According to Ole Hansen, head of commodity strategy at Saxo Bank, moreover, “The de-dollarization seen by several central banks last year when a record amount of gold was bought looks set to continue, thereby providing a soft floor under the market.”
And speaking to CNBC, the manager of the AuAg ESG Gold Mining UCITS ETF (exchange-traded fund), Eric Strand, said in December that 2023 would yield a new all-time high for gold and the start of a “new secular bull market”, with the price exceeding $2,100 per ounce. “Central banks as a group have continued, since the great financial crisis, to add more and more gold to their reserves, with a new record set for [the third quarter of] 2022,” Strand said. “It is our opinion that central banks will pivot on their rate hikes and become dovish during 2023, which will ignite an explosive move for gold for years to come. We therefore believe gold will end 2023 at least 20% higher, and we also see miners outperforming gold with a factor of two.”
Forecasts for agricultural commodities are also moderately tilted to the upside. “Although Canada is enjoying a solid harvest this year, estimates of U.S. corn, soybean, and wheat production have been revised lower as the drought has widened,” BMO Economics recently noted, while also warning that aluminium prices will likely fall due to continued growth in global production and lumber prices “remain under pressure from residential construction headwinds”.