Commodities warrant cautious optimism, not exuberance, in 2023

BY MEGHA MANDAVIA | UPDATED JAN 17, 2023 07:05 AM EST

U.S., China and Europe have better outlook, sparking metals-price rally

Commodities bulls have left the pen, ready for a long run. Odds are that 2023 will end with industrial-metal prices, at least, higher than they are now. But there are a few important caveats, especially for the economic bellwether, copper.

For now at least, the bulls are in charge. Three-month copper futures are trading at $9,100 a metric ton on the London Metal Exchange, already up 9% in 2023 according to FactSet. Aluminum futures are up 13%. And iron-ore prices rallied by almost 50% from early November to the end of 2022, according to CEIC, a data company.

The world economy is turning out to be more resilient than many anticipated. China’s reopening, and signs of stronger government support for its beleaguered property market, are key factors driving the metals rally. But data from the U.S. and Europe hasn’t disappointed either. U.S. inflation remains high but is now clearly trending downward. And the mild winter in Europe has limited damage from the increase in natural-gas prices.

At the same time, metal inventories look low. Stocks at the end of December on the London Metal Exchange were over 50% lower than at the beginning of 2022, exchange data shows. The fall in aluminum stocks has been especially precipitous—they ended last year at 447,250 metric tons, down from more than 900,000 metric tons at the beginning of 2022. Aluminum stocks at the Shanghai Futures Exchange also finished the year sharply lower.

It is no surprise then to see industrial metals rallying sharply—particularly given the good possibility of a very strong uptick in Chinese economic activity after the Lunar New Year.

Still, there are a few important caveats. First, the timing and scale of China’s housing-market rebound remain quite uncertain. While households are sitting on high savings levels, Chinese credit data—often a good leading indicator for the housing market—remains mixed at best. Growth in medium and long-term loans to households, much of which is mortgages, ticked up to 5.3% month over month in December from 4.8% in November on a seasonally adjusted, annualized basis according to Goldman Sachs. But overall growth in outstanding, economywide debt and equity finance slowed further to 9.6% year over year, from 10% in November.

China’s economy is climbing out of a deep hole. The official manufacturing purchasing managers’ index weakened further to 47 in December—the weakest since February 2020. Imports of most key industrial commodities, with the exception of oil, also fell in December according to ANZ Bank.

Second, the Federal Reserve could still prove bond investors wrong and stick to its tough stance in late 2023. In that case, the combination of a stronger than expected dollar and, possibly, a tough U.S. recession could prove to be a toxic mix for commodities.

And third, copper inventories have held up far better on the LME than aluminum and zinc: Copper stocks ended 2022 essentially flat, rather than down, for the year according to Wind data. Copper prices will benefit from new demand from clean-energy applications over the next few years—but in the short run, inventories and China are still probably the key swing factors.

A better than expected outlook for all three of the world’s major economic engines—the US, China and Europe—is cause for cautious optimism. But caution might still be the operative word for commodity investors until clearer economic and monetary signals emerge from China and the US this spring.