Why Commodities Are (Still) a Smart Hedge in 2023

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• We’re in the midst of a commodities Supercycle — one that began during the first year of the pandemic and could last another 10 years.
• Goldman Sachs’ Jeff Currie, who specializes in commodities research, says commodity bull markets are “invariably driven” by a critical mass of people, not the relatively few high-income individuals who control financial markets.
• Jeff joins us to discuss why decarbonization impacts the commodities space, what really drives tangible-goods inflation — and what commodities to invest in to make the most of the Supercycle.

We talk about commodities quite a bit on Top Traders Unplugged. But in a macro sense, “the commodities space is ‘unloved,’” says Jeff Currie, the global head of Commodities Research in Global Investment Research (GIR) at Goldman Sachs’ London office. 

“People are under-invested in energy and commodity equities. The same thing can be said about metals and mining. The index space is a total sleeper.” 

Put simply, dwindling resources need capital, and they continue to be a smart investment.

He calls it the “revenge of the old economy.”

When Jeff finished his master’s degree in economics at the University of Chicago in 1990, in the middle of the first Gulf War, oil prices were $40 a barrel. As he remembers it, the only companies hiring were oil companies — and oil was the largest post-global fungible market. 

So, he went on to earn a Ph.D. at University of Chicago, writing an award-winning dissertation about the geographic extent of the oil market. Nearly 30 years later, Jeff still obsesses over the economics of energy and other commodities. He is known as a bit of a maverick, but his contrarian streak is often quite prescient: Back in 2007, he foresaw oil topping $100 a barrel months before it did for the first time. In 2013, he warned us about the biggest decline in the price of gold in 30 years — two days ahead of the crash. 

In late 2020, he predicted a new commodities boom driven by underinvestment in supply, arguing that a bull market had begun. He believed that the COVID-19 pandemic could be a “catalyst for a commodity Supercycle.” 

It’s safe to say that, three years later, he’s still bullish on commodities, especially oil. 

Jeff joined me and Cem Karsan on a Global Macro episode of Top Traders Unplugged to talk about the economics of commodity trading in 2023 — and beyond.

Volumetrics and vulnerability

“Ultimately, commodity bull markets in inflation are created by low-income groups, not the high-income groups,” Jeff argues. “And there’s no exception to this observation.”

That might seem “disturbing” to some because people tend to believe that those with low incomes are the most vulnerable to inflation. 

“The actual truth is they create it,” says Jeff, who explains that commodities are physical markets — they’re what we call volumetric markets, which are driven by the quantity consumed. 

“To be bullish on the oil market or the copper market, it’s really easy,” he adds. “You look at the volume consumed versus the volume supply. If demand is bigger than supply, you’re bullish. There are no discount factors, no interest rates. … Either you long or short the stuff.”

Financial markets are another thing entirely. 

“How do you quote an equity market [with] billions of dollars of market cap? How do you quote an economy [with] trillions of dollars of output?” he asks. “The concept of volume is not defined. But things like interest rates and discount factors are very important in terms of creating a valuation.” 

The economics of commodity markets are “just volume consumed,” and financial markets are “simply dollars invested,” Jeff says. 

But when we think about high-income groups around the world, “what do they control?” he asks. “They control dollars. Are there very many high-income people in the world? Absolutely not. So they cannot control volume. In contrast, the low-income groups control volume.”

Even Elon can’t hoard all the corn

Can high-income groups create financial inflation? Absolutely. Elon Musk, for instance, could (with his $150-ish billion) cause inflation across a number of financial markets. But could he create inflation in a commodity market? 

“No, it’s numerically impossible,” says Jeff. “There’s not enough high-income people who could create physical-good inflation.”

Corn is a good example of a tangible asset that can’t be subject to inflation unless a large group of people influences demand. Arguably, a high-income individual consumes about the same amount of corn as a low-income individual.  

“The only possible way high-income groups could create commodity inflation (or physical good inflation) is they would have to hoard,” Jeff notes. “Is hoarding all the world’s corn — or oil — even possible? Absolutely not.”

There’s only one commodity the world’s richest people could hoard: gold. But even that presents some difficulty. Consider all the gold at Fort Knox, which is stored in a relatively small amount of square footage.

“There’s somewhere around $150 billion of gold in the [GOLD.AX] ETF right now,” Jeff says. “You could put all that gold in your office. It may break the floor because it weighs so much, but you could fit it in your office.”

If you prefer an energy analogy, imagine this: At its peak, the ETF on oil was somewhere around 200 million barrels — between $12 billion and $15 billion worth of crude. You’d need 200 Very Large Crude Carriers (VLCCs, aka petroleum tankers) to transport all that oil.

“Can you imagine parking 200 VLCCs out on the Thames? You can’t do it,” says Jeff. “You’re not going to be able to store all that oil. That’s a critical point here: It is numerically impossible for high-income groups to ever create physical-good inflation.”

The long history of commodity bull markets proves that eventuality. 

“What was the 2000 China story driven by?” Jeff asks. “Four hundred million low-income rural Chinese. What was the 1970s commodity story driven by? The war on poverty.”

As we look to the future, he thinks the interplay between decarbonization and income inequality will only become more critical.

Decarbonization and the ‘dirty sector’

How is today’s inflation different from previous eras, such as the financial crisis of 2008-09 and most of the 1970s? 

Jeff says our current inflationary period is characterized by a focus on decarbonization. 

“As a result, it’s very difficult for the [energy] sector to create the supply response it typically would under these types of pricing conditions,” he notes. “Look at how undervalued many of these publicly traded companies are. They currently have the economic incentives to do share buybacks with their cash flow, as opposed to drilling for new oil.”

And it’s not just happening in the oil sector — it’s happening in all commodities. What Jeff characterizes as “the old economy” — “the dirty sector” — creates 80% of the world’s emissions. The new economy, on the other hand, favors “clean” energy and more sustainable products. But (sidestepping any debate about decarbonization) investors can’t play it safe by ignoring the old economy. 

“Unfortunately, that’s the approach many investors have taken,” he says. “As a result, the ability to attract capital into the space has been severely constrained.” 

Distortions and drags

Jeff argues that we saw evidence of that constraint last year. And it’s not just in the oil equities: Metals and miners, as well as agriculture producers, all have a significant disconnect between the capital they attract and the reality of underlying commodity prices. The disconnect “really boils down to the ability to get a supply response,” says Jeff. 

When it comes to decarbonization, he advocates a carbon tax because it doesn’t create these distortions in investment. Environmental, social and governance (ESG) measures are a “blunt tool” that creates much higher prices than a carbon tax would. 

“But more importantly, these distortions are, essentially, a carbon tax — [but] the tax revenues are not collected by governments.”

That’s a conundrum he says should be addressed by policymakers.

“I don’t want to get into the politics of whether it’s right or wrong to be investing in [fossil fuels]. … The bottom line is, people are not stopping consuming it,” Jeff says. “The only way you’re gonna get people to stop consuming it is to tax them.”

Hot and heavy metals

So, if we look a decade forward, what’s the most asymmetric way to make a profit on the commodity Supercycle as it is?  

The bottom line: The commodities space needs “trillions of dollars of CapEx (capital expenditures) … and equities are going to be the conduit,” says Jeff. “You want to own some of the commodities as inflation hedges.” 

He recommends a “basket of commodities to capture that upside. … Uranium would be an excellent example of something you’d want to own in this environment. You want to own the metals and miners because they’re going to enable the Green Revolution.” 

The “big six” green CapEx metals — copper, aluminum, silver, nickel, lithium and cobalt — are smart bets because they enable our transition to cleaner energy. Rare earth metals such as lanthanum, cerium, praseodymium and neodymium are used to manufacture electronics like smartphones, memory chips and cameras, as well as military and defense products like night-vision goggles and precision-guided weapons.

However, if Jeff had to choose just one commodity in which to invest, it would be oil. 

“It’s the one that drives the macro variables,” he says. “And you cannot stop investing in something that’s strategically so important.”

“Revenge of the old economy,” indeed.

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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.