What a 2023 recession could mean for commodities investors

2022 has been a year of marriage and (partial) divorce in the commodities market. When the war broke out in Ukraine, energy prices skyrocketed with non-renewable fuel sources taking most of the gains. While some of those gains have been given back at the stock and sector levels, it's been another undeniably strong year for the asset class.

In fact, this year is the second straight year of outperformance for the world's benchmark commodity index against the world's benchmark equity index. 

So will 2023 make it three from three? 

Both Citi and Morgan Stanley argue yes but both research houses are backing different commodities to get there.

In this wire, I'll go through both research papers with an emphasis on the commodities that matter most to Australian investors - namely iron ore, crude oil, gold, and the battery minerals power couple (lithium and copper).

Some data on broker calls and price targets were sourced from FNArena. Parts of this article were first published by our new colleagues at MarketIndex - you can read that here.

Welcome to the brave new world

• What will be the impact of a US-led, globally felt recession?
• When will China reopen and will demand stack up like it used to?

Well, I can answer both questions for you now. 

Both Citi and Morgan Stanley have a US recession priced in for the first half of next year. But both houses also believe Australia will avoid a recession. 

The latter is a little more complicated. Citi is more bullish on the energy transition theme after a bumpy couple of years. But the research house's commodities czar Ed Morse argues the past two years have set up a big 2023 for battery minerals and other new-world energy sources:

Morgan Stanley is less enthusiastic (if only tactically) because of the China story.

"...Near-term the [team] remain cautious about China battery 'over-production', subsidies being partly phased out and consumer caution on EVs in China..." 

On that note, let's get specific about the two houses' differing views on the key commodities Australian investors care about. And there's no better place to start than iron ore.

Iron ore: Citi (tactical bull) vs Morgan Stanley (top preference)

Citi: "Iron ore is expected to remain strong in the near term (rising to $120/tonne) and could follow through (rally up to $150/tonne) in the bull case of a major China credit easing during 1Q’23 and an accelerated China re-opening plan materialising. We continue to see iron ore as the way to get exposure to ‘China reopening’."

Yet in spite of this forecast, Citi downgraded Rio Tinto (ASX: RIO) earlier this month to neutral and Fortescue Metals (ASX: FMG) to sell in late November. They have no rating on BHP Group (ASX: BHP). 

Morgan Stanley: "Iron ore sits top of our order of preference, with a temporary first-half rally driven by a seasonal pick-up in steel production against weaker supply. Improved sentiment combined with earnings upside risk makes risk-reward more attractive. As such, we maintain our Metals and Mining overweight."

Of the major three iron ore miners, Morgan Stanley's preferred name is Rio Tinto (ASX: RIO). Their other key commodity preference for 2023 is aluminium, with local play South32 (ASX: S32) receiving the broker's pick. You can read more about the aluminium story here.

Crude oil: Citi (relatively bearish) vs Morgan Stanley (holds one of the top calls for 2023)

Citi: While oil demand does not look to decline more quickly until the 2030s and after, oil demand growth looks likely to fade as the world moves out of recession after 2024. In a deep recession bear scenario, prices could fall to the mid-US$60 level.

Morgan Stanley (28 November): Oil will outperform gold and copper, with Brent crude, the global oil benchmark, ending 2023 at $110. Our balances point to a modest oversupply in the coming months. However, the market will likely return to balance in 2Q23 and undersupply in the second half of 2023.

Morgan Stanley has the top price target on Bridge Street for Woodside Energy (ASX: WDS) of $41/share.

Gold: Citi (redemption year) vs Morgan Stanley (two top ASX picks)

Citi: The Federal Reserve won the first few rounds against gold bulls in 2Q/3Q 2022. But the yellow metal is finding a second wind into the New Year. We remain comfortable with our longstanding gold market outlook and leave our base case outlook unchanged ... $2,000/oz+ seems possible in a calendar 2024 context.

Morgan Stanley: Gold and silver could still see downside initially as the last of the rate hikes come through, but the team see more upside into the second half. 

MS' top picks for 2023 include Evolution Mining (ASX: EVN) and Newcrest Mining (ASX: NCM). They have an equal-weight rating on Northern Star (ASX: NST). By contrast, Citi has a buy on Northern Star and Newcrest Mining with Evolution Mining bearing a neutral rating. 

For more on the gold story, you can check out the latest edition of Signal or Noise:

Macro

Signal or Noise: Will the RBA pause rate hikes in early 2023?

View

Battery Minerals: Citi (Higher for longer on lithium) vs Morgan Stanley (bearish on lithium and copper)

Citi: "We continue to have conviction in our higher for longer outlook for lithium given its high exposure to the rollout of EVs globally, but most notably in China. A potential supply chain destock is a near-term risk but China's reopening plans may have substantially reduced any potential downside."

Citi has a buy rating on Allkem (ASX: AKE) and a neutral rating on IGO (ASX: IGO). Interestingly, Pilbara Minerals (ASX: PLS) was downgraded to a sell rating in late October despite projections of double-digit increases for the price of spodumene through FY24.

"The net of modest copper demand growth (driven by the resilient decarbonisation sectors) and strong mine supply growth is an anticipated decline in the call on scrap in the short term. In the long term, copper demand growth is poised to increase as transition trends intensify."

Morgan Stanley: They remain cautious about copper, calling for prices to trough in mid-2023 as mine and supply grow, tipping the market into surplus ... Tactical demand risks and added supply see our sector team move to underweight on lithium.

They downgrade Allkem to underweight. IGO and Mineral Resources (ASX: MIN) remain underweight and equal weight respectively.

One last note

So there they are - the stocks, the commodities, and most crucially, the calls from two leading research houses. But as is with just about anything, all roads eventually lead back to the US Dollar. The Dollar has been the trade of the year without question, and as Citi's FX team points out, more volatility in the US Dollar Index (DXY) is bad news for commodity markets.

Unless it continues to go down...

You see - everything is linked to macro!