Commodity prices can hold their own in 2023, but with some effort
In 2022, commodities finished as best performing asset class
In my 20 years’ experience in the cable and wire industry, I learnt that once commodities wake up, expect unpredictability. The bullish cycle in commodities that emerged in 2020 could take years to subside. Just as commodity markets have been dominated by the dollar in 2022, we expect them to be shaped by underinvestment in 2023.
Despite recent price declines, commodities finished as the best performing asset class in 2022. Commodity cycles never move in a straight line; rather, they are a series of price spikes, with each high and low higher than the previous spike.
Commodity prices operate as an economic function of stabilizing supply and demand. So, once high prices have rebalanced the market in the short-term, these prices are no longer needed and come crashing down as we saw recently. Economists argue that global economic development is set to bounce back with China’s reopening; Europe improving its energy efficiency; and a slowing of the aggressive Fed rate hikes in the US. These underpin our expectation that commodities (TR S&P GSCI) will return 43 per cent in 2023.
New capex cycle
The main factor to watch out for in 2023 is if we will see a new capex cycle takes root. Only better relative returns will draw capital. With an increase in commodity prices, we are getting close to this rotation capital. The 3-year moving average of the Sharpe ratios of commodities versus Nasdaq are beginning to meet, and in the past when these two join paths, capital begins to flow. Historically, it begins with rotation away from growth in Big Tech toward growing profits from energy and industrial firms.
We put a higher emphasis on the history of poor returns and intense instability over ESG considerations as to why investors have been slow to re-enter this space. Only sustainable higher returns in 2023 can confirm this. The first stage of the Old Economy’s revenge happened in 2022, through higher interest rates that drove down New Economy valuations.
I expect 2023 to be a continuation of second stage, where continued high commodity prices and Old Economy cashflow lead to outperformance, which is the only method that will recover the trust of investors and once again reward capex in the space.