Material Matters: Commodity Price Forecasts Revised

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– Commodity prices forecasts revised
– Danske Bank expects a recovery in prices in 2H11
– Natixis cautions a short-term correction is possible
– JP Morgan adjusts forecasts, bulks see the biggest changes

By Chris Shaw

According to Danske Bank, the two major commodity price sell-offs experienced in the past quarter have been driven by falling oil prices. This reflects both the unwinding of speculative positions and the International Energy Agency ((IEA)) releasing strategic oil reserves.

The IEA release effectively removed some of the geopolitical risk premium that had supported oil prices in recent months, states Danske. The removal of this premium is seen as good news for the world economy.

What should also prove to be good news for economic growth is the expectation of a soft landing in China. Danske's view is inflation in China now appears to be under control, provided another food price spike can be avoided. A soft landing in China should help sustain demand for raw materials.

An improving economic outlook leads Danske to suggest the current soft patch in prices will prove temporary, meaning a rebound in prices in the second half of the year. Into 2012 the bank continues to expect further limited gains to most raw materials.

What is likely to limit price gains in 2012 is expectations of a stronger US dollar, as next year Danske expects the focus of the market will turn to Fed tightening. As such a move would support the greenback it would also weigh on dollar-denominated commodities and so counteract at least some of the gains from an improving global economic outlook.

Longer-term there is no change to Danske's view a commodities super-cycle will remain in place. This implies sustained upward pressure on prices for another five to 10 years. A challenging supply side should also be supportive, as falling grades and declining reserves are making expanding production difficult.

Looking at the different markets, for oil Danske is slightly less upbeat than the International Monetary Fund ((IMF)) in terms of global growth assumptions. This means a slightly less optimistic outlook for oil demand.

As the supply side should also have some issues, Danske expects the global oil market will remain tight, so supporting oil prices around US$120 per barrel at the end of next year. Shorter-term Danske has trimmed oil price expectations, seeing the price trading between US$105-$115 per barrel in coming months, against a previous forecast of US$110-$120 per barrel.

In terms of year average prices Danske is now forecasting prices for Brent crude of US$111 per barrel this year and US$117 per barrel in 2012, which is down from previous estimates of US$114 and US$119 per barrel respectively.

For the base metals the last few months have been a volatile period, with copper being sold off more heavily than aluminium and nickel losing more than 15% over the past three months. Driving the sell off have been weaker economic data and fears over the euroland debt crisis.

But as Danske notes, the fact China, as a key consumer of base metals, may be about to recover from a mid-cycle slowdown is a clear positive. While a cautious view for the coming months is appropriate according to Danske, there remains potential for price gains through the second half of this year and some limited upside for 2012.

For aluminium, the cost curve remains elevated thanks to high energy prices, to the extent a large number of producers would incur a deficit if prices were to fall below US$2,000 per tonne. Danske is forecasting average prices of US$2,570 per tonne this year, down from US$2,600 previously, and US$2,600 per tonne in 2012. This is down from a previous forecast of US$2,700 per tonne.

With Chinese demand set to pick up in the second half of this year and with production stalling, Danske expects the copper market to remain firm through next year. Forecasts are for average prices of US$9,400 per tonne this year and US$10,125 per tonne in 2012. 

For zinc, Danske Bank is forecasting average annual prices of US$2,320 per tonne this year and US$2,283 per tonne in 2012. For nickel, forecasts stand at US$24,422 and US$24,750 per tonne respectively.

Danske expects gold will average US$1,468 per ounce this year and US$1,413 per ounce in 2012.

While Danske Bank sees signs of an improving global economic outlook, Natixis Commodity Markets notes current data are indicative of a soft patch for the world economy, the key being how long this soft growth period will last.

European governments are dealing with deficit issues and US economic data remain weak, while data out of China also show a slowing economy. With rising raw material prices squeezing household incomes and so acting as a constraint on growth, the demand outlook for commodities is currently muted.

On the supply side there continue to be disruptions, particularly as a result of the earthquake and tsunami in Japan in March. How severe these supply and demand factors are will affect the immediate outlook for the global economy predicts Natixis, especially as potential further policy responses are not yet known.

Inflation also remains an issue but Natixis expects headline inflation to subside gradually as the second half of 2011 unfolds and as the year-on-year base effects become more favourable. Such an outcome would be a positive for economic growth as monetary authorities would then be able to look at relaxing monetary conditions.

Natixis suggests a decline in inflation among developing countries would be a positive economic scenario, possibly generating a period of stronger growth in global demand. But given the need to deal with issues such as sovereign debt and QE3, there remains scope for a correction in base metal prices before there is any acceleration in global economic growth.

Either in expectation of a slowing in global economic growth or to reflect tightening in credit and other policies Natixis notes there has been a de-stocking of base metal inventories across the developing world in general and China in particular. This leaves markets especially sensitive to the prospects for any re-stocking ahead of an expected recovery in economic activity. 

Across the metals, Natixis sees the aluminium picture as especially opaque, as while Chinese production has been rising the country's stockpiles are falling. This implies a strong demand environment and leaves Natixis cautiously optimistic, forecasting average prices of US$2,600 per tonne this year and US$2,750 per tonne in 2012. 

The recent pick-up in copper prices has been driven by a re-opening of the LME-SHFE arbitrage window and growing supply side concerns. Chinese re-stocking and ongoing supply side issues will push the copper price higher predicts Natixis, the group's forecast calling for average prices of US$9,570 per tonne this year and US$10,600 per tonne next year.

Long-term the fundamentals for lead remain very positive in the view of Natixis, this given the rapid acceleration in the global car fleet. But rising stockpiles mean the market may need a clear improvement in fundamentals to overcome a current stock overhang. Forecasts stand at US$2,650 per tonne this year and US$2,850 per tonne next year.

The nickel market outlook for 2011 had been one of two halves and Natixis suggests prices appear to have factored in much of this scenario. The first half saw a deficit but new mine supply is now coming on stream, something expected to push the market into surplus by year's end. This won't prevent prices moving higher, as evidenced by Natixis expecting average annual prices for 2011 of US$25,300 per tonne and for 2012 of US$26,500 per tonne.

Expectations recent Chinese de-stocking may soon swing back to re-stocking pushed tin prices higher in early July and Natixis continues to expect an eventual return to Chinese imports and so a global market deficit. This supports forecasts of US$29,850 per tonne thus year and US$32,000 per tonne in 2012.

Zinc prices have recently traded back towards February highs but Natixis remains of the view any improvement in market fundamentals remains an expectation rather than a reality. The market should move into deficit net year, which is enough for Natixis to forecast average annual prices this year of US$2,400 per tonne and next year of US$2,700 per tonne.

Gold investment remains dominated by risk notes Natixis, especially with the respect to the European debt crisis and concerns over the debt ceiling in the US. Supply from the mining sector is increasing but so too is investor demand, though jewellery demand has slowed in most regions.

Natixis continues to see the gold market as in something of a liquidity-fuelled bubble, which means calling the top is difficult when factors remain supportive for the price. But above US$1,600 per ounce the market appears to be pricing in most of the positive factors, so the bubble appears closer to the end than the beginning.

Forecasts reflect this, Natixis expecting average cash prices of US$1,510 per ounce this year and US$1,300 per ounce in 2012. For silver forecasts stand at US$26.80 per ounce and US$27 per ounce respectively.

The platinum group metals will hold current levels better in the view of Natixis, as forecasts for platinum stand at US$1,810 per ounce this year and US$1,800 per ounce next year, while for platinum estimates stand at US$800 per ounce for 2011 and US$875 per ounce for 2012.

Along with the reviews of Danske Bank and Natixis, JP Morgan has similarly updated commodity price forecasts. The most significant changes have come to iron ore estimates, which have risen by 5% in 2011 and by 9% in 2012 to account for stronger than previously expected demand. 

The postponing of an expected decline in prices has seen increases to forecasts in later years as well, so JP Morgan now expects average annual iron ore prices of US$178.10 per tonne in 2011, US$175 per tonne in 2012 and 2013 and a long-term price of US$80 per tonne, The latter has increased from US$70 previously.

With copper expected to be in deficit in both 2011 and 2012 prices should be supported, while JP Morgan also expects the aluminium market will remain tight through this year before moving back into a surplus in 2012. This implies prices will grind higher rather than enjoy a breakout during the coming 18 months.

JP Morgan's forecasts for copper and aluminium stand at US437c and US448c per pound for the former and US117c and US124c per pound for the latter, These forecasts incorporate only modest changes to previous estimates. JP Morgan's forecasts equate to US$9,634 and US$9,877 per tonne for copper and US$2,579 per tonne and US$2,733 per tonne for aluminium. 

More significant increases have been seen in precious metal price forecasts, with JP Morgan lifting its gold estimates to US$1,587 per ounce for 2011 and US$1,688 per ounce for 2012. The new forecasts are 9% and 15% higher respectively. For silver JP Morgan has lifted estimates by 8% this year to US$39 per ounce and in 2012 by 14% to US$36 per ounce. 

Changes have also been made to coal price estimates, JP Morgan notes lingering supply problems and strong demand from Asia are continuing to support metallurgical coal prices above US$300 per tonne for best quality coal. Until new capacity comes on stream in a few years, price risk appears to be to the upside. 

For hard coking coal JP Morgan has lifted estimates by 8% this year to US$295 per tonne, in 2012 by 4% to US$264 per tonne and its long-term forecast by 20% to U$150 per tonne. Changes to forecasts for semi-soft coking coal, PCI coal and thermal coal have been more modest, though the broker's long-term price forecasts for semi-soft has risen by 20% to US$120 per tonne. 

The changes to commodity price expectations have flowed through to changes in earnings estimates and price targets for resource stocks covered by JP Morgan, but there have been no changes in ratings. This means Rio Tinto ((RIO)) and Newcrest ((NCM)) continue to be rated as Overweight, while BHP Billiton ((BHP)), Iluka ((ILU)) and Alumina ((AWC)) are still all rated as Neutral.

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