CCRV - Commodities: Taking The Long View
2023-05-17 23:45:00 ET
Summary
- So far in 2023, commodities have generally not delivered for investors.
- Commodities could remain risky given near-term Fed actions and investor sentiment.
- We believe there are several reasons why the asset class could pick up steam from here.
By Hakan Kaya, PhD
Recent volatility aside, multiple forces could support the commodity asset class over the long term.
So far in 2023, commodities have generally not delivered for investors, with the S&P GSCI Index lagging major stock and bond indices despite persistent inflation and growth risks. However, given what we consider current recession-level prices, we believe there are several reasons why the asset class could pick up steam from here.
First, the Federal Reserve’s monetary tightening is likely close to over. The central bank’s monetary actions have been a headwind for commodities over the past 18 months, resulting in a significant decline in lending and, most importantly, the risk appetite of investors. Observing systemic troubles, the Fed may decide it has overtightened and change policy direction—in which case commodities would be in a strong position to capitalize over the rest of the year.
Second, if risk takers change their views and start pricing in slowing growth without a recession, the market could quickly shift its focus from sentiment to fundamentals. News from China, which has been reopening; Europe, which is rebounding from last year's energy crisis; and the U.S., which is deploying “green capex” to pay for ambitious climate goals, may suggest that demand cannot be met by current supply, especially given already low commodity inventories.
Third, U.S. debt dynamics could support demand for some commodities. In our view, leaders will eventually realize, despite the debt-ceiling controversy, that more issuance is needed. Unfortunately, key buyers such as China, Russia and the petrostates may be reluctant to pick up the new bonds for political reasons, while those in other markets may be risk-averse, requiring the Fed to purchase much of the issuance. That could postpone inflation normalization, causing investors to demand hard assets to offset a weakening dollar and gold to manage volatility around debt-ceiling uncertainty.
Beyond the forces discussed above, we see increasing aversion to investing in risky long-cycle investments that are considered ESG-negative, while governments may be reluctant to reduce bottlenecks in the carbon-emitting "dirty" commodity sectors—maintaining supply constraints. And despite recent weakness, we think demand is likely to recover and become progressively stronger, not only due to the return of risk appetite but because of mandates like those found in the U.S. Inflation Reduction Act and Europe’s Net-Zero Industry Act, which will require the availability of metals and sustainable fuels for economy-wide electrification.
Yes, commodities could remain risky given near-term Fed actions and investor sentiment, but eventually we believe these risks are likely to fade, replaced by pricing of compelling fundamentals.
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Commodities: Taking The Long View