Commodities | May 10 2010
By Chris Shaw
The worsening of financial conditions in not only Greece but a number of other European economies is causing a tightening in global credit markets and, as Citi points out, is likely to undermine European growth in the coming few years.
Debt restructuring is inevitable in a number of economies in Europe, as aside from Greece Citi notes the likes of Portugal, Italy, Spain and Ireland are at a high risk of being forced into such moves. Potential credit losses would hamper the ability of banks to support growth in these high risk economies.
But as Citi notes the issues would be unlikely to stop there, as the economies of France, Germany and the UK would also come under pressure given they have exposure to these higher-risk economies of as much as 10-20% of GDP.
What the crisis has done, in Citi's view, is take pressure off China with respect to a revaluing of its currency, as the real effective exchange rate of the renminbi has rebounded by 7% since the euro decline began in November of last year.
Citi notes this has had the effect of reducing Chinese export competitiveness, which in turn means the need and pressure for the currency to appreciate against the US dollar has meaningfully decreased. This means the recently rumoured one-time appreciation of the renminbi has now become unlikely.
The decline in China's export competitiveness is important because it makes the Chinese economy more vulnerable to weaker European growth, as Europe accounts for 20% of total Chinese exports. This means Chinese exports to Europe are actually greater than their total exports to the US market.
Given this, Citi suggests the Greek crisis again highlights the need for China to develop a more independent and international currency. To achieve this, China needs to increasingly use the renminbi for international transactions, especially with countries where China has a trade deficit.
As a result, Citi suggests the current environment may actually present China with a a good opportunity to introduce a change in its currency regime. This suggests at least an increase in the level of flexibility of the renminbi exchange rate against the US dollar, as this would also increase the willingness to use other currencies than just the US dollar in transactions.
While the European debt crisis may eventually see changes to China's exchange rate policy, the shorter-term impact has been to push down commodity prices, as the market is becoming increasingly concerned about growth prospects both in China and globally.
But in the view of Barclays Capital, this commodity price weakness is coming at a time when commodity specific fundamentals are actually firming and where recent macro data for commodity related sectors have been supportive.
Barclays notes anecdotal evidence suggests the recent price correction in base metal markets has actually sparked a rise in physical buying interest from consumers, as physical premiums in nickel and aluminium have been firming.
As well, it notes the falls in the copper price have re-opened the Chinese import arbitrage window with respect to price differentials between the London Metals Exchange and Shanghai Futures Exchange.
But as the crisis in Europe continues, Barclays is somewhat cautious as it sees scope for the euro to continue to weaken. Its EUR/USD forecasts reflect this, being lowered to 1.20, 1.20, 1.25 and 1.25 respectively on a one, three, six and twelve month basis.
Risk in the shorter-term is the euro moves even lower than Barclays is forecasting, as it takes the view the crisis is likely to get worse before it gets better. This means the US dollar may gain further, which would keep commodity prices under pressure.
GSJB Were has a similar view, also pointing out macro data releases have been encouraging for the commodity outlook, supporting fundamentals that remain sound for selected industrial metals and minerals.
The issue at present, according to GSJB Were, is that the euro debt crisis has investors in risk aversion mode, and until this changes GSJBW expects base metal prices are likely to remain under pressure.
Another issue for aluminium in particular is further increases in Chinese smelting capacity, which appear set to continue to accelerate this year. GSJB Were expects Chinese smelter production will increase by 14% in 2010, but even then capacity utilisation will only be at around 70%.
Given this, GSJB Were suggests the aluminium market will need to see an unprecedented degree of supply discipline for it to rebalance itself over the next five years. Such an outlook is hardly a positive for the price outlook in the broker's view.
While the oil price has dropped almost US$10 per barrel in recent sessions, Barclays again doesn't see the move as justified by fundamentals, as if anything these fundamentals suggests a pick up in oil demand is actually gaining pace.
Demand data out of Japan rose in March in year-on-year terms for the second month in a row, while non-OPEC demand continues to increase by more than consensus expectations. European demand is falling but Barclays has already been aggressive in this regard, so it suggests there is little chance this comes in below its expectations.
Given this view Barclays sees little chance the oil price fall to the bottom of the current US$80-$90 per barrel trading range is anything more than a transitory period, with prices expected to average US$86 per barrel for the June quarter and US$85 per barrel for 2010 overall on the group's numbers. Commonwealth Bank is not as bullish, forecasting an average oil price of US$83 per barrel for the June, September and December quarters of 2010.