Commodities | Nov 15 2012
– Gold forecast to gain
– Oil and the US fiscal cliff
– Implications for commodities of Obama's re-election
– China and LNG demand
– Copper and met coal updates
By Chris Shaw
When compared to previous rounds of QE, the gain in gold prices since the end of August has been relatively disappointing in the view of Deutsche Bank. Part of this may be explained by the divergence between the various players in the gold market, as while holdings in physically backed ETFs continue to move higher there has been a steady reduction in speculative length in the gold market.
While Deutsche continues to expect the gold price will move higher, this is dependent on a resumption of US dollar weakness. Such weakness may become evident before the end of the year, as Deutsche expects the current QE program will be extended to include long-term Treasury debt at the next Fed meeting in December.
There is also the risk of a further downgrade in US Treasury debt as US authorities face up to the fiscal cliff, with this likely acting as a positive catalyst for the gold price in Deutsche's view. Underperformance of silver and PGMs relative to gold is expected to continue.
In terms of the US fiscal cliff, which is a combination of tax rate expirations and government spending cuts scheduled to come into effect from January next year, Citi suggests any fall over the cliff that triggers such measures poses a significant short and medium-term threat to the US economic outlook.
A combination of budgetary austerity and tax increases is likely to generate a short-term contraction in US GDP growth of around 6% in annualised terms on Citi's numbers, while unemployment would also be expected to increase. This would be enough to push the US into recession.
In turn, this would impact on US petroleum demand, Citi suggesting as much as 1.1 million barrels per day of domestic oil demand could be permanently destroyed if the US goes over the fiscal cliff. This impact would not be felt in full until 2015 or 2016.
Demand destruction in the US should lower global oil prices by as much as US$10-$15 per barrel according to Citi. Longer-term the broker suggests the permanent impact of the US fiscal cliff should be more modest at around US$3 per barrel if all else remains equal.
Still on energy markets, Citi points out these were hardest hit on the day following President Obama's re-election. With Obama back for four more years, Citi has identified a number of of issues in energy markets likely to arise during this term.
One is Keystone XL, a pipeline to move Canadian oil from Alberta into the US. This proposal was initially vetoed by President Obama on national security grounds, but a re-application for the permit has been made.
With a new pipeline route to skirt the Ogallala Aquifer in Nebraska, which was the most environmentally sensitive part of the pipeline, Citi expects a decision will be made in 2013 with a positive decision now more likely.
LNG exports will also be addressed, likely following a report from export regulators at the US Department of Energy. Citi's view is it will be difficult to refuse additional exports, especially to some countries with which the US has a free trade agreement.
Citi suggests Obama's re-election likely means the Renewable Fuel Standard portion of the Energy Independence and Security Act will remain intact for the time being. The mandated 10% of the gasoline pool being comprised of ethanol at a time when gasoline consumption is declining is turning the US into an ethanol exporter, while also creating an uneconomic oversupply of biofuels.
Subsidies for renewables have been under pressure and the fiscal cliff sees Citi suggest these pressures will remain in place. At the same time, a significant green side of Obama's support base should sustain some support for renewables in the broker's view. In contrast, a number of production tax incentives are likely to be removed.
The Jones Act was designed to protect American shipping and the ship-building industry but Citi suggests the act, which requires inter-coastal trade uses US flagged vessels, may be changed under Obama as attempts are made to deal with a regional crude oil glut.
Growing US oil production could also see increased pressure for export permits, while at the same time prompting a review of the US Strategic Petroleum Reserve. This is because the reserve, which at present stands at around 700 million barrels, needs to be maintained at such a level given the increases in US production and fall in consumption.
The other issues likely to come up for discussion in Citi's view is where this strategic reserve of petroleum products should be stored, while the broker also expects increased discussion on the possibility of a carbon tax being introduced.
With respect to other commodity markets, Citi suggests initial expectations of Obama's re-election were for a positive reaction for prices, as such an election result would mean a continuation of the existing loose monetary policy.
This was not the case, as LME prices weakened in early November, Citi seeing this as a sign investors had moved on from the election and were turning their focus to other issues such as the fiscal cliff. Citi's view is long-drawn out negotiations and a possibility of tipping over the cliff wold be a double negative for industrial metals, as a possible recession would impact on metal consumption and economic uncertainty would be supportive for the greenback.
Overall, Citi suggests the impact of Obama's victory appears negligible on industrial metals shorter-term, as greater consequences are likely to come from any policy fallout from leadership changes in China.
For JP Morgan, a key question in energy markets is as to when natural gas will displace price-moving quantities of diesel demand across the transportation sector. China is again an important element to this question, particularly as new policy directives include higher subsidies for shale gas produced through 2015 when compared to the subsidies on offer for coal bed methane. This implies shale gas development is a high priority in China.
On the demand side JP Morgan points out China's NGV development will first prioritise large trucks and buses, which implies some potential substitution away from diesel. This trend should continue, as the broker expects gas use in China will rise to around 380kbdoe by 2015 and to 750kbdoe by 2020.
This will cut into annual diesel demand growth, while JP Morgan expects it will also act an important curbing mechanism on oil prices.
Turning to the base metals, Macquarie suggests China's copper imports are set to see a temporary fall given a short-term decline in copper availability. The fall could be significant, Macquarie estimating refined imports could decline in October by as much as 30% in month-on-month terms.
Any such change in imports, especially if combined with an increase in refined stocks, would decimate apparent consumption calculations in China according to Macquarie. The increase in Chinese copper stocks over the past two months has been a concern, Macquarie attributing the change to an extensive de-stock at the smelter/semis level.
A Chilean holiday and production strike impacted on exports from that country late in September, the disruption to exports representing around 5% of global supply. With Chilean exports taking around 30 days to reach China, any reduction in refined copper availability should now start to impact stock levels in the Chinese market in Macquarie's view.
In the bulks, Macquarie notes fundamentals in the met coal market are starting to improve. As this is occurring when Chinese mills are low on inventory, the expectation is prices improve through the end of the year. This will be too late for 1Q contracts, where a rollover at US$170 per tonne is most likely in Macquarie's view.
Looking at the market's dynamics, Macquarie notes some recent concerns are now lessening, as Australian producers have less urgency to try to liquidate material as was the case a couple of months ago, while supply from other regions are now starting to come under pressure.
Chinese domestic supply is also falling as prices have weakened, which implies higher prices are needed to reincentivise this material. Macquarie suggesting the marginal met coal tonne appears to be at prices around US$150 per tonne.
Into 2013, Macquarie suggests one area of the market to watch is Chinese policy with respect to exports of metallurgical coke, as if an existing export tax in China is revoked there is believed to be more than two million tonnes of potential incremental supply that could impact on either the seaborne market or be sold back into domestic supply.
Macquarie suggests met coal remains oversold at present, with US$200 per tonne viewed as a level that can be sustained on average in coming years.
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