While the start of a new cycle remains a key call for 2024, we deem that commodity investors, or rather commodity speculators, have gotten ahead of themselves, particularly when it comes to oil and gold. For oil, the combination of expected output cuts, geopolitical tensions, and an improving economy has boosted speculative positioning. As for gold, the rate-cut narrative, in combination with Chinese central bank buying, has led to similar excessive positioning.
Unsurprisingly, Switzerland shows up as a main trading and refining hub, exporting 1,564 tonnes of gold in 2023, cementing its spot as the world’s largest trading and refining hub. Marking a five-year high, every third ounce of gold produced in 2023 has passed through Switzerland.
Gold: Will the gold rush continue?
Central bank buying seems to have become the dominant driver of the gold market lately. Last week, the World Gold Council reported that central banks continued to add to their gold reserves in February, which pushed gold prices to new record highs. We generally share the view that central bank buying should stay strong and supportive of structurally higher gold prices, considering ongoing geopolitical tensions and a desire to be less dependent on the US dollar. However, we do not expect a constant increase in buying but rather a volatile sideways trend. In fact, the data published last week shows that this year’s volumes are well below last year’s.
Unfortunately, this data does not paint the full picture, as it does not show demand from other sovereign institutions, such as wealth funds, which have also been adding to their gold allocations. Another factor that has been fuelling the bullish market mood is China. While demand has picked up last year, it has slowed again more recently. Our expectation for Chinese gold demand is similar to that for central bank buying: it should stay strong, but we do not expect a constant increase.
While short-term price risks remain skewed to the upside, we see the dominance of speculative traders in the futures market and the single-sided narratives as warning signs, implying more medium-to longer-term downside than upside.
Oil: A soft footed rally
Oil prices edged up to USD 90 per barrel and the bullish narratives are varied. The global economy continues to surprise positively on the margin, lifting oil demand projections. The petro nations maintain their supply curbs, led by Saudi Arabia, a strategy that artificially props up prices.
Meanwhile, geopolitics is keeping the uncertainty and fear level elevated. Despite all these reasons to see a tightening oil market, the fundamentals so far do not provide the evidence. Oil storage in North America, Europe, and Asia, where reliable data is available, remains well balanced. Logistics issues, including those in the Red Sea, are well managed.
We struggle to share the bullish expectations. Oil demand is unlikely to expand meaningfully. The US labour market remains tight and the upside for commuting is limited. Challenges in China’s property market are limiting construction activity, while rapid electrification is starting to undermine road fuel consumption. Moreover, there is likely to be some reaction to elevated prices.
While we question the frenzy and the current rallies in oil and gold, we look to industrials as a more sustainable beneficiary of an investment-driven upturn.
Equities: Time to shine for industrial stocks
Over the past 12 months, the industrial sector slightly underperformed cyclicals, however, going forward, we see early signs of a turnaround for the sector. The recently released ISM manufacturing purchasing managers’ index (PMI), which usually leads industrial activity by one to two quarters, has finally bounced back into expansionary territory for the first time since October 2022, signalling that one of the worst stretches for manufacturing in the US is probably behind us.
Historically, the relative performance of the industrial sector is closely linked to the level of the ISM manufacturing PMI index and, assuming our cyclical growth recovery thesis for H2 2024 bears fruit, points to an outperformance of the sector ahead.
The sector is also heavily exposed to secular growth themes including artificial intelligence, electrification, automation, and robotics. While consensus is expecting 7.4% of earnings growth for the sector for 2024 on a year-over-year basis, we see upside to that number on the back of operating leverage. Within the sector, we have a relative preference for the machinery and equipment subsector, which should become a main beneficiary of a cyclical recovery, with the subsector’s growth momentum already supported by secular growth themes. This is followed by the transportation subsector, as overall freight flows would benefit from strengthening industrial activity.
What does this mean for investors?
Rather than the commodity market running hot, we see industrial stocks as a more sustainable investment: an economic recovery, the energy revolution, and global reshoring are all likely to back the sector for years to come. Within industrials, we prefer the machinery and equipment subsector, which should become a main beneficiary of a cyclical recovery.