Commodities 2023: From supply concerns to weaker demand

Commodity Fundamental Outlook

2022In 2019, supply concerns were the dominant factor affecting commodities. When the new crown epidemic had already had a huge impact on the global supply chain, the outbreak of the Russia-Ukraine war further strained the supply chain. With soaring global inflation and aggressive interest rate hikes by major central banks, the main factor affecting commodity prices may shift to the demand side.

In the commodity market, from investment products such as gold to industrial metals, energy, to wheat and coffee, different commodities have different price drivers behind them. This article mainly discusses three macro factors that may affect commodity prices as a whole: Economic recession, Russia-Ukraine conflict, and China’s relaxation of epidemic control.

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Can the central bank achieve a soft landing for the economy?

Since the 1970s, high inflation has once again become the core problem facing the world economy. In order to curb the high inflation in the past 40 years, major economies have generally adopted the method of tightening monetary policy, raising interest rates and shrinking balance sheets. Will continue to maintain a tough hawkish stance.

The Fed will raise interest rates seven times in 2022, accumulatively raising interest rates by 425 basis points. In addition, central banks in developed economies such as the Bank of England, the European Central Bank, and the Reserve Bank of Australia have also withdrawn from the long-term quantitative easing, ending the era of cheap money caused by low interest rates .

Recent inflation data show that inflation seems to have peaked, but the growth rate of inflation in various places is still higher than the target level of the central bank. In this case, the central bank has little choice but to continue to tighten monetary policy . So the biggest question facing markets is whether the central bank will be able to curb inflation without causing serious damage to an indebted economy. Of course, commodities are no exception.

Weakness on the demand side may not be entirely a bad thing, with some markets, such as industrial metals, structurally pressured by supply difficulties, lower demand can help balance supply and demand.

However, containing inflation without causing long-term damage to aggregate demand is actually a small probability event, and commodity markets need to be vigilant about this as time goes into 2023. With many economies likely to be in recession over the next few quarters, the sole concern of economists should be how deep those recessions will be.

How long will the Russia-Ukraine conflict continue?

After the Russian-Ukrainian conflict broke out in February 2022, commodities soared across the board, and although they later retreated, prices remained high. In order to sanction Russia, Europe has significantly reduced its energy imports from Russia, but it has also caused Europe to face a serious energy crisis.

Russia is a major supplier of fertilizer raw materials. Due to the sanctions imposed by developed economies such as Europe and the United States, the export of Russian fertilizer raw materials is far below the level before the outbreak of the conflict. In addition, the conflict has forced the transportation of bulk commodities to avoid Black Sea ports and railway hubs as much as possible, and this deviation from long-established routes will inevitably bring upward pressure on commodity prices.

Ukraine is a major exporter of agricultural products, and the economic losses caused by this conflict to the export of Ukraine’s main agricultural products are also incalculable. In short, the Russia-Ukraine conflict has severely disrupted commodity markets in both countries and globally and, unfortunately, does not appear to be in any way abating and will remain a key theme going forward.

China eases epidemic control

At the beginning of December 2022, China announced the relaxation of epidemic control. After nearly a month of liberalization, the number of new crown infections in China has surged, which has led to a simultaneous increase in the number of hospitalizations and deaths. The market is wondering whether the new crown epidemic will hinder the economy in the short term. Recovery fears have grown substantially.

China’s response to the coronavirus outbreak has been critical to commodity markets, as the country is both a demand and a producer of many construction raw materials. China is the largest consumer of almost all industrial commodities, so any weakness in demand will affect commodity markets to a large extent.

The easing of COVID-19 control may lead to a quick recovery in China’s demand for commodities, provided, of course, that policy changes can be managed in an orderly and effective manner. This is perhaps the biggest catalyst in the commodity market right now and one to keep a close eye on.

(Written by David Cottle, translated by Chris Li)

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