Agri Commodity Markets Research Outlook 2023: Tightening the Belt
Agricultural commodities reached record nominal prices in May 2022, on the back of adverse weather, falling stockpiles, the war in Ukraine, the container shortage and various protectionist measures restricting food commodity exports. Between May and October, prices dropped 18% due to the USD strength, weak demand, a better container shipping situation, the temporary establishment of the Black Sea grain corridor and select bumper harvests. Presently, there are growing expectations for Brazil’s upcoming harvests of soy, sugar and coffee, as La Niña wanes and the wet season there has begun in a timely manner. Still, prices of agricultural commodities remain high, at about 50% higher than pre-pandemic levels, which is when we last saw some sense of ‘normalcy’ in agricultural markets.
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High prices would normally stimulate supply, but production is currently relatively inelastic to prices: area availability is limited as swaths of very fertile land are lost in Ukraine, farm input costs are high, La Niña is active and the cost of finance has increased. So there is more pressure on demand to balance the equation. Here we start to see some weakness that might continue through much of 2023. Global inflation has resulted in a loss of purchasing power globally, and subsequent hikes in interest rates could result in some major economies going into recession. A global recession would limit demand on a number of fronts, from feed and energy-related commodities to non-essential commodities like cotton, coffee and cocoa.
With this in mind, we hold a bearish view for a number of agri commodities, but the main assumption here is better weather, with the expectation of La Niña weakening and going away in early 2023, and demand being affected by a recessionary outlook in 2023. However, agri commodity stocks in exporting countries are generally low, which could result in high volatility ahead, especially if the weather does not normalize as is currently expected.
Weather: Three times (un)lucky
The expectation is for La Niña to weaken and then disappear in Q1 2023, after haunting global agriculture for three consecutive years. Some of the textbook impacts of La Niña were present: Dryness in parts of the US, Argentina and southern Brazil affected a number of crops (soybeans, corn, wheat, sugar, coffee, cotton) over 2021 and 2022. On the positive side, increased rainfall in India and Australia has led to relatively good crops in those areas. However, the overall effect is clearly detrimental to global agriculture, and supportive of higher prices. The possibility of more normal weather after La Niña fades should allow some producer countries to increase production and replenish stocks.
Macroeconomic outlook: Recession ahead
2022 is unfolding as a terrible year for the world economy, with global GDP growth seen at 2.8%, after registering 5.3% in 2021. The war in Ukraine, with a big inflation shock in its wake, ongoing lockdowns, a real estate crisis in China, and central banks around the globe rapidly tightening policies, are all starting to take their toll. RaboResearch expects global growth in 2023 to fall to a mere 2% – with many economies in recession. Inflation is expected to fall in 2023 but will stay elevated for a protracted period.
US GDP growth already stagnated in the first half of the year, albeit partly for technical reasons. In the eurozone, coming out of the pandemic, household spending buoyed growth. Looking ahead, however, we expect the eurozone economy to decline by 0.9% in 2023. Governments are stepping in to support households and companies facing a real purchasing power shock, but the bottom line is that the eurozone needs to reduce its energy consumption.
The US economy is expected to fare better than the eurozone in the coming quarters, sliding into recession from the middle of next year. Plus, the by-product of the Fed’s policy – a strong dollar – is weighing on emerging markets.
Although peak inflation may be near, price pressures are expected to remain elevated in years to come, even as central banks hike us into a recession. In a worsening geo-economic environment, de-globalization and government intervention look set to accelerate, with consequences for efficiency and prices.
Currencies: Dollar remains king
Since the start of 2022 there has been repeated speculation that USD strength may have peaked. So far, USD bears have been wrong-footed.
USD strength is undermining world growth by pushing up the prices of USD-denominated goods for much of the rest of the world, forcing other central banks to announce aggressive rate hikes and potentially raising default risks for some of the most vulnerable emerging countries. We expect USD strength to dominate at least into the spring of 2023, and possibly longer.
Energy: Natural gas as a global commodity
2023 will be a difficult, volatile year in energy. As fears of a recession mount and sentiment turns negative, there are supportive factors on both the supply and demand front. Russian exports of oil and products have dropped significantly due to European sanctions, OPEC has shown a willingness to cut production to buoy prices, and tepid growth in drilling in the US is slowing new supply. The US only added 0.3m bpd of new production in 2022, and growth flattened over the last quarter. On the demand side, refinery runs remain strong across the world as inventories of diesel are at 30-year lows. Skyrocketing natural gas prices in Europe have led to gas-to-oil switching, further supporting diesel prices as demand will likely increase by 0.6m bpd in the winter.
Natural gas is becoming a global commodity and a proxy for power (both geopolitical and electrical): it is the transitional energy source before a wholly renewable economy is possible. The destruction of Nord Stream I & II will force Europe and the UK to rely on expensive LNG imports from Qatar and the US, again supporting prices overseas. Next winter will be a struggle for the continent as, starting in March, they will have to rebuild natural gas inventories without any Russian supply. Real constraints are back. Frictions are breaking down the globalized just-in-time manufacturing economy, and with friction comes volatility. As the narrative swings from sentiment to supply-demand fundamentals, expect prices to gyrate wildly. Remember, however, that volatility is not inherently a bad thing. Volatility represents opportunity.