Against this backdrop, our forecast calls for a flat total return for EMLD in 2022. More specifically, we expect EMLD’s 5.7% yield to be eroded by 2.5% currency depreciation and 3.0% loss from duration as interest rates rise, resulting in a total return expectation of just 0.2%.
We expect spread widening and higher Treasury yields to detract from the asset class’s positive carry this year, leaving EMD returns slightly above zero at 0.4%. We therefore do not recommend a tactical position in EMD at this time.
Emerging Market Dollar Debt
2022 Global Commodity Outlook
Emerging market dollar debt (EMD) was not immune to the headwinds facing fixed income assets in 2021. Its eight-year duration was particularly costly in last year’s rising interest rate environment, more than offsetting the benefit of coupon income and marginally tighter credit spreads. As a result, EMD declined about 2% in 2021. With spreads already below their long-run average, we think there is more room for wider spreads than narrower ones. Our view partly reflects the fact that the underlying credits have very bifurcated spreads. While spreads in the investment grade cohort are near all-time lows, those in the high yield universe remain above average. As we discussed in last year’s Outlook, this implies that further spread compression in EMD would ultimately need to come from the high yield universe. We are skeptical, considering that some of the high yield countries, such as Lebanon and Argentina, are not even current on their dollardebt payments. Moreover, we believe that investor focus will increasingly shift from catching a cyclical recovery in emerging markets toward critically evaluating whether the structural growth models of these countries are well equipped for the post-pandemic era. The high yield universe within EMD screens particularly poorly on this measure, raising the risk of wider spreads amid idiosyncratic setbacks.
Even for seasoned commodity investors, the volatility of the last two years has been out of the ordinary. Oil prices, for instance, rose nearly 60% last year following their unprecedented descent into negative territory in 2020. Such powerful reversals were not limited to energy, as most commodity prices staged a strong rebound in 2021 (see Exhibit 156). In fact, the 40% advance in the Goldman Sachs Commodity Index (GSCI) last year was the second-largest annual gain since its inception in 1970. Within commodities, the energy and industrial metals sectors were the top performers given their correlation with an improving global economy. Agricultural commodities also rallied strongly, as adverse weather conditions exacerbated already depleted inventories. But gold and other precious metals failed to keep up with the broader commodity index, even as inflation surprised investors to the upside. While it would be natural to expect commodity price gains to moderate from here, there is historical precedent for consecutive years of strong performance. Such a pattern is particularly likely today, as the above-trend economic growth that supported commodity demand last year remains in place. It could also take higher prices to entice marginal producers into the increasingly supply-constrained energy
Exhibit 156: Commodity Returns in 2021
Most commodity prices staged a strong rebound in 2021. S&P GSCI
Energy
Agriculture
Industrial Metals
Spot Price Average, 2021 vs. 2020
50%
67%
42%
43%
Precious Metals 3%
Livestock 26%
Spot Price Return
37%
54%
21%
31%
-4%
20%
Investor ("Excess") Return*
40%
61%
25%
30%
-5%
8%
Data as of December 31, 2021. Source: Investment Strategy Group, Bloomberg. * Investor (or “excess”) return corresponds to the actual return from being invested in the front-month contract and differs from spot price return, depending on the shape of the forward curve. An upward-sloping curve (contango) is negative for returns, while a downward-sloping curve (backwardation) is positive.
Past performance is not indicative of future results. Investing in commodities involves substantial risk and is not suitable for all investors.
92
Goldman Sachs
january 2022
