Valerio Baselli: Good morning and welcome. It has been a year since the Russian invasion of Ukraine. The outbreak of the conflict had a strong impact on the prices of the main raw materials, from oil to gas, from steel to cereals.
Joining me today is Nitesh Shah, head of macroeconomic and commodity research at WisdomTree, to shed some light on what to expect from commodity markets in 2023.
Nitesh, commodity prices have always been volatile, but in 2022, markets have reached new levels of turmoil. What are your general predictions for this year? And in your opinion, could the possible and desired peace between Russia and Ukraine change the cards on the table?
Nitesh Shah: A very good question. So far in 2023 commodities have continued to perform very strongly as in 2021 and 2022, albeit with the level of volatility you mentioned. I think the volatility will continue as commodities are subject to macroeconomic headwinds. Central banks in developed countries are very keen to stifle inflation and are doing so by raising interest rates. And this hurts cyclical assets, including commodities. But once this period of monetary tightening has passed, we believe commodities can excel. Indeed, there is a new tailwind for commodities this year. There is the reopening of China. China is the largest consumer of all commodities. The strong recovery we had in economic terms in 2021 and 2022 occurred in the absence of China. Now that China is participating, we will likely see raw materials take the lead. Beyond that, we believe there is a secular force that will push commodities to grow substantially for several years, thanks to the energy transition and new infrastructure spending, which will be commodity intensive, especially in the metals.
Now, the risk you mentioned regarding Russia, yes, we believe there is hope for peace. But do we think that is really possible now, in this phase where the conflict is escalating instead of easing? Probably not. But it is also clear that there would be tension in many metal and commodity markets even in the absence of the situation between Russia and Ukraine. Thus, commodities could also excel if Russia returns to supply the world.
Baselli: Historically, commodities have mostly been known as inflation hedge, which is already important, especially today. But their role is broader, right?
Shah: Yes, commodities play different roles in a portfolio. Inflation obviously plays a major role and we saw this clearly in 2021 and 2022 when inflation rose to its highest level in many decades, commodities were probably one of the only assets able to protect against that level of inflation. Furthermore, they are also a great diversifier for a portfolio. They are uncorrelated with most assets. Therefore, when trying to think of good portfolio protection, it is possible to diversify into commodities. Also, they tend to have positive skew. For example, let's take the stock markets. Stock market returns do not tend to have a normal distribution. They tend to have quite heavy tails on the bad side. So when things go wrong, you tend to have very high losses on stocks. Commodities, on the other hand, tend to have heavy tails on the positive side. So when things are going well, commodities offer larger yields, which is a very nice feature to add to a portfolio.
Baselli: To conclude, if you had to indicate three raw materials on which to bet, to buy today, which ones would you indicate? And why?
Shah: So, number one, I'm picking Henry Hub natural gas because it's grossly undervalued today. Over the past two months, it has experienced a price drop of close to 60%. In part this is due to the good weather in the United States, which meant that natural gas consumption was not high. But also because the US has become one of the major exporters of liquefied natural gas. Several plants have been mothballed and stockpiled in the United States, but are in the process of being reopened. When this happens, a large part of the inventories in the United States will flow into international markets and the oversupply situation will be resolved. So, Henry Hub natural gas.
In second place I would say base metals in general. But if I had to pick one, I'd probably pick copper. As I said, the energy transition is becoming a strong driver of demand for base metals. But beyond that, we have huge limitations in supply. The problems that are happening in Peru are an example of this and the supply of copper is being reduced.
The third choice is gold. Gold is a much more defensive asset. It acts as a hedge for our portfolio. And as I mentioned, there's uncertainty along that path this year. We don't know how quickly central banks will move towards cutting rates or halting interest rate hikes, and gold could be a good hedge in the event of a recession or financial market turmoil. We believe our models indicate that gold prices could reach new all-time highs for 2018 by the end of this year, if we incorporate consensus forecasts on macroeconomic variables. So, once again gold could hit all-time highs by the end of this year.
Baselli: Thanks a lot, Nitesh. For Morningstar, Valerio Baselli, thanks for watching.
