- Commodity investors can sometimes find geopolitical analysis to be overly complicated, just plain overwhelming or ultimately incorrect.
- Commodity Context Founder Rory Johnston, who specializes in geopolitical analysis of commodities markets, says it’s important to create firm parameters when researching investment opportunities.
- Hari Krishnan welcomes Rory to the podcast for a discussion about the relationship between the price of oil and the dollar, China’s recent COVID response and how best to use market analysis to make investment decisions.
Geopolitical analysis sometimes gets a bad rap among investors in the commodity space.
But geopolitics can give us “a sense of a parameterization of the possible,” says market researcher Rory Johnston. “The most important thing is to have a framework; to have a systematized approach to geopolitics.”
Rory is the founder of Commodity Context, a popular Substack newsletter featuring a “chart-forward,” data-driven analysis of commodities markets, particularly the oil and gas industry. With a background in political science, global affairs and global security, he believes that well-informed research can give investors an edge.
Even though market analysis is “inherently probabilistic,” he aims to “fade the noise” and provide a well-rounded perspective on global events so we can better understand how supply, demand, inflation and other variables impact the price of oil and other commodities.
Rory joins host Hari Krishnan on a Global Macro installment of Top Traders Unplugged to talk about his newsletter; the relationship between the price of oil and the dollar; and his thoughts about China’s “reopening” after the country’s recent COVID outbreak. They also tackle how to interpret the gulf between market assumptions and market predictions, and much more. Read on for a few highlights from their conversation.
March 2020: Commodities go ‘haywire’
Prior to Commodity Context, Rory led commodity economic research at Scotiabank. He left at the beginning of 2020 to join a family office — but COVID hit just as he began to shift gears.
“Commodity markets, which had been on a bit of a grind downward for the better part of the [previous] decade … went completely haywire,” he says. “First, my phone started ringing off the hook from old media contacts from my days at Scotia — like, Why is oil negative? What the heck is going on? So, I got pulled back to the oil side after tentatively trying to leave for a hot second.”
To understand what the heck was going on — and “so I didn’t sound like a moron talking to my media contacts,” he began researching the energy space with renewed vigor. Eventually, he thought he should write it all down — and publish it. He launched Commodity Context in June of 2021 as a free publication. To his “shock and amazement and gratitude,” it was a smashing success. He began to offer a paid version of the newsletter in mid-2022 and turned it into his “full-time grind.”
Today, Commodity Context has over 16,000 free subscribers and hundreds of paid subscribers. Rory offers three main product verticals: “bread and butter” thematic deep dives, posted about once every two weeks; monthly data reports called “data decks” on global oil balances and the North American oil industry; and “Oil Context Weekly,” a Friday wrap-up of major market news. He aims to provide content that’s both useful to experts in the sector and approachable for the mere mortals among us.
“I really lean into the name of the publication,” he says. “I’m not a fortune teller. I’m not going to pump a view really hard one way. The focus really is on context — whether it’s a bullshit detector or just a sniff test of some of the narratives that are bouncing on the market. … There’s plenty of stuff we don’t know, but what do we know?”
Winter 2022-23: China reopens (early)
To illustrate how Rory’s Commodity Context analysis works, he uses the example of China, which is still dealing with major COVID-19 outbreaks three years after the virus began to spread worldwide. He might present a data-driven breakdown of several hypothetical scenarios — like a few different paths toward reopening — and plot projected trajectories for each. Each hypothetical reopening scenario is associated with certain price ranges, incremental levels of demand, and other comparable data points. He’ll make adjustments as more data becomes available.
But he admits his forecasts aren’t flawless.
“In September of last year, there was a lot of debate about whether China [will] ever reopen,” Rory recalls. “Is this going to be a permanent lockdown of the country? Is ‘COVID Zero’ tied to the legitimacy, or perceived legitimacy, of the Chinese Communist party or Xi Jinping himself?”
But political analysis can sometimes lead one astray. Rory read “a lot of compelling analyses” of China’s COVID situation — one of which compared COVID Zero to the country’s former (and failed) ‘one-child’ policy. That policy stayed on the books long after it became apparent that it was unsustainable.
The author of this analysis argued that China’s draconian lockdowns could be a similar misguided policy that “for all intents and purposes, from the outside, looked insane; that was completely bizarre in its commitment to keep at that level,” Rory explains.
That’s why Rory didn’t think China would reopen as quickly as it did. But nationwide protests changed the government’s risk calculus. Within a week or so, the Communist party released plans for reopening.
Rory was wrong, but other analysts “nailed the call,” he says. “I think that if you had a really good view of what was going on and how the Chinese politburo was discussing and handling these factors, it did provide you an edge.”
Check yourself … before you risk your funds
While Rory isn’t an expert on China, he is a veteran observer and analyst of the petroleum industry.
Hari asks him whether, because oil is priced in dollars in global markets, that means the price of oil is a play on the dollar.
He thinks this chart provides “a good sniff test.”
If crude spikes in one direction and the dollar spikes in the other, people might flood into the dollar because of a risk trade. This creates both denomination effects and inverted risk-off risk-on trajectories.
“When people flood into the dollar, it’s often because they’re worried about growth or whatever. Then at the same time, people will de-risk oil,” he notes. “So I think that’s a good way of just sanity-checking yourself.”
The ‘Dollar Wrecking Barrel’
But what about if chaos erupts (a là March 2020) and the dollar rallies while the price of oil drops like a stone?
“How do I know what the loading was on the dollar vis-à-vis just a collapse in demand?” Hari asks Rory.
In October 2022, Rory wrote a Commodity Context post on this concept called “Dollar Wrecking Barrel.” He explains that typically, the dollar and the price of oil move inversely. But for the majority of 2022, the dollar rallied at the same time oil rallied. That reflected a “concern and flight to quality, flight to dollars, because of a ground war in Europe that also had a major oil element,” he says. “At certain moments, they can trend together — positively correlated — when the risk is something specifically related to the oil market.”
But to answer Hari’s question about whether one can extract the specific denomination effects (a form of cognitive bias relating to currency), Rory explains that the majority of the oil-consuming world doesn’t earn money in dollars, even though oil (as a commodity) is priced in dollars. So when we see a major devaluation relative to another currency, it’s proportionately more expensive for those consumers to consume oil.
We would assume that all else being equal, “oil would adjust gradually around that and essentially create a consumption-weighted currency index,” which allows us to extract how much of that was based on denomination effects alone versus flows effects, he adds.
“I think both of those can play in. That said, frankly, the denomination effect on a month-long timeframe is a useful framing. But day to day, it’s probably not that useful. It’s probably an over-complication of a relationship where the dollar goes up, oil goes down.”
You know what they say about ‘assuming’
Let’s say you’re an investor interested in oil and you’re intrigued by one of Rory’s out-of-consensus views about fluctuating supply or demand — which affects prices at the margins because that view isn’t baked into the price. What’s the best way to proceed?
If it’s not already apparent, first ensure the price of the commodity isn’t extraordinarily high. Before you lean on a long or short position, you should compare his analysis to your preferred supply/demand consensus outlook, whether it’s from the EIA, OPEC monthly reports or another source. Pay attention to the geopolitical assumptions that underpin that source’s outlook on surpluses or deficits.
Rory recently published a post that compared outlooks from the major monthly energy forecasting agencies.
“A lot of their assumptions are very similar,” he notes. “I think that’s important because you can say, ‘Okay, these are what I call consensus assumptions: U.S. production will grow X barrels a year; Chinese demand will grow X barrels; OPEC will do this,’ or whatever. Then you start to see the subtle differences — perhaps in assumptions about the extent of China’s growth or the extent of non-Chinese Asian growth.
“Then you can start to really pick apart the supply-demand balances,” he adds. “Only at that point should you then begin to layer on your own assumptions.”
That’s critical because even if you’re bullish after, say, you made the right call about Chinese reopening, many agencies (a consensus of them, if you will) already build in a big Chinese demand boost, says Rory.
“So is your assumption bigger than that, or smaller than that, or is it just on par? Because if it’s just on par, you actually don’t have an against-consensus view. You’re actually right in the middle.”
He focuses on supply and demand — and decomposing the balances between them — “because there are so many pieces to them,” he says. “It’s very easy to get lost in some of that minutia and lose the forest [for] the trees. But I think it’s important to know which particular tree you’re disputing while trying to make an overall macro call.”
This is based on an episode of Top Traders Unplugged, a bi-weekly podcast with the most interesting and experienced investors, economists, traders and thought leaders in the world. Sign up to our Newsletter or Subscribe on your preferred podcast platform so that you don’t miss out on future episodes.