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Economic and Market Commentary

Why Now May Be a Good Time to Invest in Commodities

Greg Sharenow
Commodities stand to benefit from underinvestment and the clean energy transition.

PIMCO has a positive outlook for commodities based on supply constraints, the transition to a net-zero economy, and their historical correlation with inflation. In this Q&A, Michael Haigh, executive vice president and commodities and real assets economist, and Greg Sharenow, a managing director who leads PIMCO’s commodity portfolio management group, explain their views.

Q: What is your near- and long-term outlook for commodities?

A: Headline inflation in most parts of the globe has been moderating, but core inflation has remained stubbornly high. Critically, commodities have tended to benefit from their extremely tight link with both inflation and inflation surprises.

History suggests that when spare capacity and investment is limited prior to a recession, supply constraints tend to emerge once demand growth resumes. These conditions exist today, so a long-term investor may view weakness stemming from a mild recession as an opportunity to use commodities to guard against inflation.

Over the longer term, the net-zero transition and deglobalization could add to upside inflationary risks. Transitioning to a net-zero economy will be commodity-intensive. We expect unavoidable bottlenecks as demand outstrips supply, setting commodities on an upward trend in coming years.

Q: What about the energy outlook?

A: In the near term, despite macroeconomic headwinds, petroleum has constructive underlying fundamentals. It is remarkable that in 2022 China experienced a demand recession for oil, yet global demand grew above trend due to growth in developed markets. We expect demand in 2023 will exceed trend growth as the Chinese economy continues to emerge from its zero-COVID policy that ended last December. As growth and travel normalize, we expect gasoline and jet fuel to be the primary beneficiaries, supporting demand despite global manufacturing- and trade-related headwinds.

On the supply side, one of the biggest structural changes stems from slowing growth in U.S. shale production, with reinvestment rates the lowest in 30 years. This ultimately strengthens OPEC’s ability to influence prices, defend against downside price risks, and capture market share. Recent actions to curtail supplies despite below-average inventories benefit investors by keeping the futures market in a state of positive carry.

Over the longer term, current levels of capital investment in energy are insufficient to meet the energy-transition challenge and global demand growth. According to the International Energy Agency and S&P, global annual investment in energy must increase from $499 billion in 2022 to $640 billion in 2030, even if demand growth slows and plateaus by the end of the decade (see Figure 1).

 

Figure 1 shows the rising trend of oil and gas upstream capital expenditures since 2020, in both real and nominal terms, as well as forecasts for 2025 and 2030. In 2020, total capex came to $342 billion, including $300 billion in nominal terms. In 2021, the total rose to $381 billion, including $358 nominal. In 2022, the total was $499 billion, all nominal. The chart projects total capex will be $597 billion in 2025 and $640 billion in 2030. The source is PIMCO, the IEA, and S&P Global Commodity Insights as of 30 April 2023.

Q: Are there opportunities in agriculture?

A: Weather is always a key determinant for agriculture. For instance, in the U.S., the largest producer of corn, starting conditions entering 2023 were bullish for prices as extreme weather caused two years of poor crops and limited inventory accumulation. While we expect crops to rebuild in 2023, good weather will be crucial for the rest of the growing season in the U.S. Climate change also appears to be having adverse effects on supplies of agricultural commodities, which is supportive of prices.

Q: How about metals?

A: Metals, the most sensitive commodity to the shorter-term industrial cycle, face a clear headwind, particularly with the Chinese construction sector lagging. Nonetheless, global inventories for some major industrial metals are at the lowest levels in decades. Longer term, the transition to a net-zero economy will likely be extremely metals-intensive. The proportion of all copper consumption devoted to green energy will grow from approximately 10% now to more than 25% of global demand by 2035, according to an April 2023 J.P. Morgan report.

As the world moves toward cleaner technologies, metals markets will be put to the test because adding supply is a lengthy and capital-intensive process.

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Greg Sharenow
Portfolio Manager, Commodities and Real Assets
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