Commodities | May 25 2011
– NAB sees little link between commodity prices and Fed's quantitative easing
– End of Chinese policy tightening would be a positive for copper
– Chinese still buyers of gold, caution warranted for silver
– Diamonds and gems a potential alternative investment
By Chris Shaw
According to National Australia Bank, there is limited evidence to suggest the strong growth in commodity prices seen since March of 2009 can be attributed to the quantitative easing policies of the US Federal Reserve.
What this suggests is there is unlikely to be increased risk of further downside to commodity prices following the expected completion of the policy in June. More likely, according to National Bank, is some moderation of non-rural commodity prices through 2012 as supply responds, but ongoing strong demand should see prices remain at historically high levels.
National Bank suggests there are two main arguments related to commodity markets at present, one being lower interest rates are encouraging credit driven speculation in commodity markets. The other is lower bond yields are causing investors to move into other asset markets as they search for improved yields.
The idea that QE has led to a debt expansion in the US carries little weight in NAB's view, as US economic figures continue to show evidence of weak credit growth. Whether low interest rates have driven investors to commodity markets to search for yield is tougher to judge, as expectations of improved global growth expectations post the GFC would have also encouraged investment in commodity markets.
This adds weight to NAB's view the major influence on commodity prices since the GFC have been the traditional drivers – supply and demand. Chinese growth has been very commodity intensive and has driven higher consumption, while growth has also been strong in other emerging economies.
Given an expectation the US Fed will gradually tighten monetary policy over a number of years, the expansion in emerging economies should continue for some time. NAB expects this will support commodity demand in coming years.
In the bulk commodity markets, NAB also sees strong global steel production and ongoing constraints to supply as supportive factors. In steel, global production rose by 6.2% in the March quarter, with China accounting for 3.6% of the increase.
NAB notes US output is also showing signs of recovery, growing by 9% in the March quarter to return to the levels achieved in September of 2008. The outlook is also becoming more positive given signs of a recovery in the US manufacturing sector.
Iron ore prices gained 5.8% in April, NAB noting prices on an exchange-traded basis have returned to pre-GFC levels. Actual prices are likely above September 2008 levels in NAB's view, this due to the move away from annual contracts.
For material shipped from Newcastle, thermal coal prices fell by 3.8% in April to an average of US$122 per tonne. Reports of shortages in the Chinese market may cause a pick-up in imports in coming months, but NAB notes there are no signs of this as yet given China's net imports of coal fell by around 10,000t in the March quarter.
The recent floods in Queensland provided a boost to met coal prices but NAB points out from 2012 to 2014 there are expected to be a number of new projects adding to global supply. This increase in supply is expected to largely keep pace with demand growth, something NAB expects will support prices at elevated levels.
With production reports for the March quarter now filed, Citi notes copper output from companies in its coverage universe fell around 60kt or 3.6% short of expectations. While some of this may be the result of project start-up issues, Citi suggests most of the shortfall relates to bad weather and lower grades.
For 2011 as a whole Citi expects total refined copper production to increase by about 3.4% relative to 2010, while total mine supply should be up around 6%. Risk to these numbers appears to be to the downside at present.
Historically, part of any shortfall in the copper market is made up by increased scrap supplies, but Citi suggests a 240kt annualised shortfall would be too much for scrap alone to make up.
On the demand side of the copper market, Citi notes the major concern remains Chinese demand, this stemming from ongoing moves to tighten monetary policy. This is moderating growth in the Chinese economy and impacting on sentiment. Citi doesn't expect sentiment will recover prior to the People's Bank of China signalling an end to further monetary tightening measures.
The copper market at present is dealing with the opposing forces of weak primary production and weak real demand. As the former is well known, Citi suggests the latter is of more importance to investors. Given expectations an end to Chinese policy tightening will mark a low for sentiment and the copper price, Citi remains optimistic for the second half of 2011.
Physical markets should offer the first signs of any improvement, Citi noting the scrap to metal discount has stopped falling further and actually moved up last week, as have copper physical premiums in Europe. If these moves can be sustained into the northern summer, Citi expects investors will turn more positive towards copper.
In the precious metals, Commonwealth Bank notes World Gold Council numbers indicate global gold demand was 981.3t in the March quarter. This is an increase of 100t from the same period last year and reflects stronger investment demand.
Much of the investor interest is coming from China, CBA pointing out Chinese investment demand in the March quarter totalled 90.9t, more than double the number for the March quarter of 2010. CBA suggests negative real savings rates in China continue to support demand for alternative assets such as gold, a trend expected to continue until Chinese inflation rates slow.
In the silver market, Standard Bank suggests the latest CFTC data indicates a similar pattern is emerging in the COMEX silver market as developed in the weeks before the share market correction early in May.
The similarity of the trading pattern leads Standard Bank to caution the market could see another significant correction in coming weeks, especially as falling exchange traded fund levels indicate growing investor disinterest.
Global investment manager Covenant Financial Services suggests with economic conditions remaining difficult, financially stretched Americans and Europeans are being forced to sell diamonds and gems at depressed prices.
In the view of the group's chief investment officer, Steve Shafer, this trend offers investors the potential for big returns uncorrelated to financial markets. Shafer is already putting together a portfolio of stones in an attempt to take advantage of what is viewed as a large, multi-generational transfer of wealth from the West to the East.
Similar to gold, Shafer suggests investors are looking at gems as stores of value that can appreciate in an inflationary environment. This, plus forced selling at attractive prices, is attracting more buyers, especially those in China and the Middle East looking to diversify their investment portfolios.
