Will Commodities Gain 43% This Year?
Welcome to the Sustainable Money Mail. Making long term macro forecasts is a fool’s errand, but that’s never stopped us before. So here’s our thoughts on the coming year.
The one thing we’re almost certain of is that 2023 is going to be an uneven year for every liquid market (you could even have a go at selling straddle/butterfly options if you’re into that sort of thing). Deutsche Bank predicts that the all-important S&P 500 (currently around 3,800) will rise to 4,500 in the first half, drop by 25% as the almost inevitable recession bites into earnings, and then bounce back to 4,500 to close the year as investors front-run the recovery.
Rates
Many analysts identify that the transition from inflation to recession will be one of the big themes of 2023. The street is pretty confident that the Fed will raise rates in February, probably by 25 bps (taking the Fed funds target rate to 4.5 - 4.75%), with a decent chance they’ll opt for a larger 50 bps hike. February is the first of eight Fed meetings scheduled for 2023, and the expectations for the following seven are a lot less certain.
Inflation has been cooling lately, with November CPI sitting at 7% - comfortably below June’s 9% peak, but significantly higher than the 2% target rate. The Fed has already expressed concern about 6% wage growth (it’s nice to know that the country’s top bureaucrats have been thrown into a panic at the prospect of the working man’s wages rising for the first time in a decade). The Fed may be concerned that when inflation cools off, it will still sit above the 2% target, and J Powell has indicated that he will keep hiking rates until inflation is forced below the target (some investors have been talking about double-peak inflation. Although Powell hasn’t mentioned this explicitly, he presumably thinks that killing off inflation now will keep it at the target for a while). Apart from wage growth, the other factor that could continue to drive inflation in the face of rate hikes is spiking commodity prices, and that brings us to our main topic.
Commodities
Commodity prices are on a historic run, and one of the first banks to call the bull market is sticking to its guns in 2023. Way back in late 2020, Goldman Sachs advised its readers to go long commodities, predicting that the post-pandemic recovery would trigger a multi-year supercycle. Even as global demand seems to be slowing, Global Head of Commodities Research Jeff Currie thinks that commodities will be the best performing asset class this year. In fact, Currie predicts that commodities will net investors 43% returns in 2023.
Currie’s thesis is a pretty simple one. People need commodities, and production capacity hasn’t been expanding over the past decade thanks to low prices and the “tech valuation” effect that meant equity has been funneled away from commodity E&P companies.
There’s some evidence that the capex cycle has already started as a response to high commodity prices over the past six quarters. The top 42 U.S E&P companies invested an estimated $54.9 billion in 2022, a 38% gain on 2021. On the flip side, reinvestment rates are still at an all time low of 35%. The growth was led by oil and gas companies, and there’s good evidence that oil and especially nat gas will be heading lower in the short term, driven by a warm winter and filled storage capacity in Europe. (Incidentally, the U.S is expected to transition to a net oil exporter in 2023).
Lithium
As ESG investors, we’re particularly interested in Lithium, a crucial component in rechargeable batteries. Lithium prices are up over 100% since the start of last year, although they’ve seen pressure in the past few months as demand outlook cools. S&P Global sees lithium maintaining its strong support in 2023 as EV production accelerates globally. Lithium hinges on the Chinese market, where a third of new cars are electric. As a relatively young industry, investment in lithium production is amongst the lowest of any commodity, and there’s little evidence that the capex cycle will catch up with demand any time soon. With supply restricted and demand accelerating, we think 2023 is going to be another good year for lithium.
CME runs a lithium futures market based on Fastmarkets' lithium hydroxide price assessment, but it has very low trading volume. There are also a few publicly traded lithium companies, including one we covered here.
Throughout this year, we’ll be reporting on small cap companies that can benefit from the strong commodities market. With tech valuations in freefall, an unpredictable rates markets, and a U.S consumer recession on the horizon, it’s the perfect time to be looking for cheap value investments. Stay tuned for more.
Note:
All opinions are the author’s own. This is not investment advice. Please consult your financial advisor before making investment decisions.
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