Commodity Cycles in 2023
In my 20 years’ experience in the cable and wire industry, I have learned 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.
Best resource class 2-years running and likely again in 2023
Despite the recent price declines, commodities finished the year 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, the high prices are no longer needed, and prices come crashing back down as we saw recently.
Economists argue that global economic development is set to bounce back with China seeing the reopening happen, 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% in 2023.
Will the new capex cycle take root in 2023?
The main factor to watch out for in 2023 is if we will see a new capex cycle begin to take root. This needs investment and only better relative returns will draw capital. With the decline in the appraisal of the new economy and increase in commodity prices we are getting close to this rotation capital. The 3-year moving average of the Sharpe ratios of commodities versus the NASDAQ are beginning to meet, and it has been seen in the past when these two join paths, capital begins to flow, and historically it begins with rotation away from growth in big tech toward growing profits from energy and industrial firms.
Return of capex will drive the next leg higher
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, and 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 cash flows lead to outperformance, which is the only method that will recover the trust of investors and once again reward capex in the space.
A year of underinvestment
Just as commodity markets have been ruled by the dollar in 2022, we expect them to be molded by underinvestment in 2023. Despite the recent price declines, commodities finished the year as the best performing asset class with c.20% returns (S&P GSCI), as investors were able to bank the price spikes from earlier 2022 through the roll yield. It is critical to remember that commodity supercycles never move in a straight line; rather, they are a series of price spikes with each high and low higher than the last.