MUFG: Commodities Markets 2023 Outlook

January 30, 2023

2022 was an extraordinary year for commodity markets. Despite depleted inventories and spare capacity nearly exhausted across most of the commodities complex, capital in 2022 proved to be unresponsive to near record prices as market positioning remained skewed for a recession.

Fast forward to today, global commodity markets face the most macro uncertainty since the onset of COVID in spring 2020 – from balancing Europe heading into recession, the Fed trying to soft land the US economy and China inching towards reopening.

With the US dollar too dominant to get long, but fundamentals too tight to get short, the bearish macro outlook will likely spur volatility across the commodities complex for most of H1 2023. However, with China reopening, the eventual end of rate hikes and a US dollar peak all likely by the summer, these improving fundamentals alongside prevailing supply scarcity, is set to turn into a meaningful tailwind for commodities in H2 2023.

Beyond these cyclical drivers, the structural challenges facing commodities – that pre-date both the war in Ukraine and COVID – remain unresolved. Deglobalisation, decarbonisation, the structural rise in demand induced by government policies around redistribution and the near-decade of underinvestments in carbon-intensive capex with supply scarcity inadequate to meet today’s policy-induced demand – all principles of our supercycle commodities thesis – set to move top of mind as soon as the current macro headwinds are in the rear-view mirror.

More amply, our conviction remains that, whilst not transpiring in a linear fashion and rather in a sequence of price spikes, the supply constrained commodities supercycle will be a decade long – 3 years to generate track-record, 3 years of spending to generate cost inflation and 3-4 years of investment to generate supply.

Examining commodity subgroups signals more homogeneity in 2023 with the principal commonality being the navigation of the global macro slowdown on demand:

• Energy (bullish). Tactically cautious but structurally bullish on oil, whilst the acute tightness in EU natural gas markets overlooks the benign US natural gas outlook.
• Base metals (bearish-to-neutral). As the most cyclical commodities, base metals will suffer from the uncertain demand outlook – remain selective.
• Precious metals (neutral). Asymmetric payoffs as downside is limited in the event of further hawkish rate hikes given depressed positioning and central bank support.
• Agriculture (neutral-to-bullish). Another tight year with grain markets (akin to oil), comprising low inventories as well as a low beta to global growth.

From a financial performance perspective, despite commodity price deflation since last summer – stemming from central bankers raising the cost of capital and draining market liquidity, both in physical and paper markets form – the Bloomberg Commodity (BCOM) index outperformed every major asset class for a second consecutive year.

The last time this turned into a 3 year string of outperformance was between 1977-79. We believe history will repeat itself in 2023 as the supply constrained supercycle enters its next phase.