Commodities | Sep 13 2010
By Chris Shaw
Physical demand looks set to push gold prices higher in the view of Barclays Capital, as the group suggests consumers are now realigning their price expectations for the metal.
According to Barclays this has been evident in wholesale demand emerging firstly at US$1,060 per ounce then at US$1,160 per ounce, with stronger industrial demand the main driver. An increase of 14% in year-on-year demand in this category in the June quarter helped offset an 8% fall in jewellery demand in year-on-year terms for the same period.
Barclays does expect jewellery demand will pick up in the September quarter as the gold market is entering a seasonally stronger demand period, though higher prices do pose something of a risk to this view.
This is especially the case in the key Indian market, as Barclays points out gold demand in that market is becoming increasingly fragile given prices are at record levels. A good monsoon period and growing concerns over the potential for higher prices should be enough to outweigh this risk however, offering a solid floor for the price of the metal in the group's view.
Turning to the bulk metals, Macquarie notes the latest port data shows Brazilian exports of iron ore surged in August to record levels. According to the broker this reflects both some de-stocking and a return to full capacity at Vale's operations.
The data indicates Brazilian iron ore production in August was 28.86 million tonnes, which implies an annual rate of around 340 million tonnes. This is well above the previous high from July 2008 of 315 million tonnes in annual terms.
Macquarie expects Brazil will export a total of 304 million tonnes of iron ore this year, which compares to total exports in 2009 of 266 million tonnes. In 2011 this figure is forecast to increase to around 346 million tonnes.
The figures implied by the latest data are in line with Macquarie's previous estimates and so haven't changed the broker's view the global iron ore market is set to tighten in the first half of 2011. This is based on two points, the first being there appears little scope for any expansion in the global iron ore supply chain beyond the first half of 2011.
As well, Macquarie expects Chinese steel production should recover strongly after energy induced cuts between now and the end of this year. EU and non-Chinese demand generally is also expected to be strong in the final quarter of this year, so with other producers such as Australia struggling to significantly lift output at present the outlook is for a tighter market into 2011 in the broker's view.
With respect to oil, Deutsche Bank has not changed its view physical fundamentals in the market remain weak at present. Inventories are at elevated levels and the forward contango in prices has widened in recent weeks, implying an oversupplied market.
In Deutsche's view this means any price rallies at present are based on weak, shaky fundamentals, so it may take some other drivers to push oil prices higher. One such potential driver is higher equity prices, as the months leading into mid-term elections in the US tend to be positive for share prices.
Deutsche's research shows in 18 of the past 19 mid-term elections the S&P500 Index has rallied by an average of 8%. Since January 2009 the correlation between equity prices and the oil prices has strengthened to the extent 50 points on the S&P500 equates to around US$4 per barrel for the oil price.
Deutsche suggests this implies there is scope for oil prices to rally above US$80 per barrel by December. While higher oil prices are likely in coming months even given the current weakness in market fundamentals, to make any move higher more sustainable Deutsche sees a need for a decline in US inventories and a move in the crude oil forward curve towards backwardation.
Looking at commodities in general, Deutsche suggests the strong rebound in the global economy appears to be fading given weakening signals from leading economic indicators. So far industrial production (IP) levels have not followed the weakening trend in other indicators but Deutsche expects IP growth rates will moderate in coming months.
This implies a moderation in economic growth, an example being Deutsche's forecasts for Chinese GDP growth of 9.6% this year, falling to 8.6% in 2011. The structural shift in the Chinese economy remains a key variable for commodity prices, but weaker global growth is likely to weigh on sentiment with respect to commodities.
Looking at the base metals in more detail, Deutsche estimates the aluminium price is now trading 13% below the 90th cost percentile, which implies higher cost smelters are operating at a loss at present. Medium-term the outlook for aluminium remains an oversupplied market, which suggests price pressures will remain for some time at least.
In copper, Deutsche notes inventories continue to move lower, a trend that is supporting prices for the metal given the market appears to be balanced or running a slight deficit. Prices at present are well above the marginal cost of production, while the broker notes there is scope for fundamentals to tighten further given recent production disappointments and a weak outlook for mine grades.
Stainless steel production appears to have stabilised and this has helped push nickel inventories lower, while Deutsche notes the marginal cost of production at present is around 33% below spot prices.
Near-term the broker expects a deficit in the nickel market but the longer-term view remains one of a surplus, meaning nickel's fundamentals are not as positive as for copper. As with nickel, zinc's current fundamentals are supporting the price as stocks are declining and smelting margins are coming under pressure in Deutsche's view.
RBS has a similar view on the positive outlook for copper, particularly leading into London Metals Exchange week starting October 11th. According to RBS, copper has the best fundamental market condition at present meaning it should be the first of the base metals to go into supply deficit in 2011.
In contrast RBS sees idle capacity overhangs as likely to weigh on both nickel and zinc prices going forward, something that should limit performance relative to copper prices.
One noticeable trend leading into Metals Exchange week according to RBS is an uptick in mining merger and acquisition activity, as stronger prices and stronger cash flows for most miners have led to a potential shift in focus from survival to expansion.
The trend has been relatively significant, as while in 2009 the major diversified miners completed just four deals of more than US$500 million with a total value of US$8.7 billion, so far this year there have been eight deals of similar magnitude with a total value of better than US$60 billion.
Given strengthening cash balances across the mining sector and an expectation this trend will continue for several years, RBS suggests there is scope for the desire for growth by companies in the sector to deliver stretched valuations, particularly if commodity prices can rise further from current levels.
