Goldman Sachs’ 2023 commodity markets outlook had anticipated a substantial return of over 40 per-cent by the end of 2023 for commodities (S&P GSCI TR Index). As the first quarter of 2023 draws to a close, S&P GCSI spot prices closed the quarter at a -2.81 per-cent loss. As was the case in many financial markets, the S&P GCSI saw its biggest decline in the first quarter in the week of Silicon Valley Bank’s collapse – gold being the glaring exception.  Of course, this is by no means indicative of how commodity markets will perform for the remainder of the year. Nevertheless, the impact of the ongoing banking on the inflation-duration investment cycle (elaborated below in Figure 1) for commodities remains to be assessed. This spotlight aims to do precisely that, considering some of the macroeconomic assumptions and models proposed in Goldman Sachs’ 2023 commodity outlook. 

Understanding the Inflation-Duration Investment Cycle

The inflation-duration investment cycle is a tool useful for understanding investment in commodities and commodity market behaviour, relative to inflation and interest rates. It loosely correlates with the Merril Lynch Investment Clock – although it is a bit more specific to commodity markets.

Figure 1 - The Inflation-Duration Investment Cycle. Adapted from Goldman Sachs Commodity Outlook.

When Goldman Sachs published their 2023 Commodity Outlook, they affirmed that at present, the commodity market was still in the first stage of the inflation-duration investment cycle. Crucially, the 2023 Commodity Outlook explains that in addition to the current high-inflation, high-interest rate macroeconomic environment, commodity markets are confined in an underinvestment super cycle such that unless there is a sustained increase in capital expenditure (capex), increasing demand cannot trigger a supply-side response hence creating inflationary pressures in the short-term. The remainder of this spotlight will sum up the overarching macro-level geopolitical supply-side risks impacting three core sectors of the commodities market: agriculture, rare earth minerals, and energy markets. 

Agriculture in Q12023

S&P agriculture indices (GSCI Agriculture, GSCI Livestock, and GSCI Grains) outperformed the S&P GSCI with GSCI Livestock being the best performing index considered in this spotlight, gaining 5.94 per-cent this quarter. Agriculture and Grains lost 0.61 per-cent and 2.57 per-cent, respectively. 

At the macro-level there are two factors that will keep grain prices high, despite losses in value in the first quarter of 2023. These factors are the supply-side issues resulting from the Russo-Ukrainian War, despite the recent extension of the Black Sea Grain Initiative, and climate change – which is already having some impact on grain yields. As hypothesised at the start of the Russo-Ukrainian war, grain prices skyrocketed as the two countries contribute to about half of the world’s grain supplies. The wide use of grain in human and animal diet means that the precarity of grain supply will likely underpin most food-related price rises and contribute significantly to the cost of living crisis, globally. For that reason, the extension of the Black Sea Grain Deal on March 18 was of great relief for the global food supply chain. However, despite the extension there are two items still on the snag list: (i) a disagreement between Moscow and Kyiv over how much longer the Grain Deal will run for, and (ii) Russia banning major grain exporter – Cargill – from exporting Russian grain, which has already impacted futures’ prices. 

Short-term risks impacting the supply of agricultural commodities also consist of grain supply, as they are crucial for animal feed. In addition to this, avian influenza outbreak in poultry supplies, which are not limited to just the United Kingdom, are having impact on related goods. Avian influenza outbreaks have been reported in the United Kingdom, United States, the rest of Europe, and there are fears that avian influenza and eventual egg shortages are also felt in South America. Long-term impacts of zoonotic diseases like avian influenza are difficult to quantify. Notwithstanding, after the outbreak of COVID-19 and the ensuing pandemic, there has been formal research dedicated to the matter which would suggest that countries with highly-industrialized, high-density agricultural industries run a higher risk of having disease outbreaks harm crop and livestock supplies. Thus, balancing land use and industrial density with growing populations’ driving up demand will be of importance if governments want to avoid severe shortages of crucial food items. 

Energy Markets in 2023Q1

The three S&P energy indices considered in this spotlight – GCSI Natural Gas, Global Oil, and Global Clean Energy – all lost value quarter in 2023. Natural gas especially took a substantial hit, losing 44.43 per-cent of its value at the end of trading on March 31. Oil lost a little over five per-cent throughout the opening quarter whereas Global Clean Energy’s losses were below the one per-cent mark. 

The stand out commodity here is natural gas (including LNG) and this is in large part because of the “geopolitical struggle between Europe and Russia” which will play a crucial role in dictating natural gas markets for the foreseeable future. As severe sanctions on Russian oil and gas were confirmed by the European Union throughout 2022, the bloc has not yet dealt with the fact that there is still strong demand and necessity for those commodities. Although some effort by means of REPowerEU have laid the groundwork for a shirt to alternative energy supplies, European countries have begun to look elsewhere for natural gas supplies. One such effort has been made by Italy who has looked to further increase imports of Algerian natural gas. 

Another recent trend has been importing Indian-refined petroleum products derived from Russian oil, despite embargoes. This shows that short-term procurement of oil and gas into Europe could well become economically and politically costly until alternative energy supplies are not secured. As the necessity for reliable energy supplies begin to outweigh the political value of sanctions on Russia, European countries may well find themselves having to prioritise one over the other. A pessimistic outlook that may be, but it is already materialising; as France settled its first LNG deal in Yuan with China. As the BRICS countries begin to trade in their own currencies the return of a multi-polar energy market might lead to less market predictability and prolonged period of macro-scarcity.

On the other hand, the political and economic urgency to expedite the green energy transition is indicative of a positive outlook for renewables markets according to the International Energy Agency’s latest industry overview. Indeed, analysis and forecasts from McKinsey share this sentiment as they expect substantial growth in solar and wind energy. Bloomberg shares this sentiment in the hydrogen sector, too. As legislation and regulation gears itself towards carbon-neutrality in the world’s three largest economies – the United States, China, and the EU – there is a genuine legal basis for optimism in renewables markets. A medium to long-term risk to watch out for, however, would be the political and economic competition over the necessary resources – such as copper – for a green transition.  

Rare Earth Metals in 2023Q1

In the opening quarter of the year, the S&P GCSI Core Battery Metals Index – which tracks stocks of rare earth metals (REM) pertinent to battery production – stagnated around the -0.34 per-cent mark. On the other hand the S&P GCSI Precious Metals Index soared 9.14 per-cent, though this was in large part due to investors backing gold and silver as the United States’ regional banking crisis erupted. 

Although the relationship between geopolitical tensions and short-term supply risks of REMs is not yet at the scale of the relationship between geopolitical tensions and the supply of agricultural and energy commodities, there is reason to believe that this will not last very long. Essentially, this is because REMs and precious metals are crucial to the green energy transition and the production of key electronics’ components like semiconductors. REMs are also becoming ever-more important for the production and maintenance of modern-day defence systems. Thus, securing REM supply chains and secondary materials is a paramount task for states and businesses looking to establish a dominant presence at the international level. As of 2020 REM exports originated overwhelmingly from Asia with Myanmar, China, and Japan accounting for over half of all exports. The United States and its European allies, on the other hand, exported just over 10 per-cent of global REM exports. Furthermore, sanctions against Russia and Myanmar have further complicated access to REM imports for Western business and countries. This is exacerbated further by Beijing’s recent efforts to improve relations with Moscow and Naypyidaw – with the latter being crucial for China’s efforts to overcome the ‘Malacca Dilemma’. 

In recognising this weak spot, both the Biden and Trump administrations took swift action to incentivise the reshoring production of crucial electronics, starting with the National Strategy for Critical and Emerging Technologies as a direct countermeasure to China’s efforts to increase its own electronics production. This was followed up with the CHIPS and Science Act and formal export controls, limiting semiconductors produced with American technology and inputs to China.  In the meantime, the United States has sought to diversify its REM supplies from Africa, where China has a considerable geopolitical presence. What the impact the ongoing China-United States rivalry over REM supplies and semiconductor development will have on prices in the short-term remains to be seen, but the medium-to-long-term protectionism and antagonism between Beijing and Washington will likely lead to REMs enjoying substantial price increases considering their growing demand. 

Summary: Outlook for 2023 and Beyond

The first quarter of 2023 carried forward many of 2022’s geopolitical dynamics and risks into global commodity markets. There have also been supply shocks, like avian influenza outbreaks and severe climate events, which have harmed the supply of crucial commodities that have further exacerbated the impacts of geopolitics on market activity. 

This is particularly visible in agriculture markets where the uncertainty on how long the Black Sea Grain Initiative extension will last is a key risk to secure grain supplies globally. If Russia’s demands for a reduction of sanctions can be made credible by its recent rapprochement with China, then an extension of the Black Sea Grain Initiative beyond the current deadline will likely result from a reduction in Western sanctions. Conversely, if the West can find ways to cope with inflation and diversifying energy supplies, then Moscow might be forced to formally accept a longer extension. The outlook on the matter remains speculative, but the consequences of a no-extension scenario could spell disaster for global food supplies within the next quarter.

Although energy and REM markets are also mired by geopolitical power struggles and risks, the potential for a drastic spillover into commodity markets and the wider economy in the short-term is, at this stage, quite limited. Although, as REMs become more intertwined and necessary for future energy markets this outlook will likely change post-2023. This is because in the absence of short-term flashpoints, the increasing pursuance of protectionist and antagonising trade policies between Beijing and Washington will very likely undo much of the economic globalisation that occurred pre-COVID. 

Hence, it is not likely that global commodity markets will break the macro-scarcity phase of the Inflation-Duration Investment Cycle in 2023 – and potentially prolong the under investment in commodities into 2024 and beyond. However, there is still a lot of 2023 to go and there is a lot of time for pressing issues to unfold and provide a clearer picture for commodity markets. Although, the current direction of the international regulatory and political environment does not offer much optimism for the long-term, with regards to increasing capex or securing crucial supply chains.

Cover photo credits to: Black Sea Grain Initiative FAQ | United Nations in Namibia