Material Matters: Bulk, Base And Precious Metals, Oil And Softs

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– Commodity markets volatile
– Bounce in Chinese economy a key
– Gains most likely in energy and base metals
– Bulks cheap, softs highly priced

By Eva Brocklehurst

Commodity markets are expected to remain volatile as we head into 2013. The forecasting debate is dominated by whether the economic softening in China has levelled out and what that means for bulks – iron ore, coal — in particular. The undercurrents creating uncertainty in the US and European economies play out across a range of products and will continue to do so in varying degrees in the new year, analysts suggest. National Australia Bank analysts suspect China's economic slowdown has found a base, although a rapid recovery is considered unlikely. They expect the US economy to strengthen in 2013, but at a glacial pace, while Europe is still negotiating its minefield of debt.

ANZ Bank analysts expect commodity markets to generally improve in the coming months. However, don’t expect strong gains. There's enough uncertainty to hold back the nervous nellies in the investment community. As has been the case for some time, performances will vary. Gains are most likely to be seen in those commodities which have been heavily sold – such as base metals and energy. The potential for softness is in the higher-priced agricultural markets. ANZ notes bulks look cheap, but an overhang of supply will likely cap iron ore prices and slow any seasonal improvement in coal prices. It appears investment funds liquidated about US$20 billion or 6% of total commodity positions in October, mainly in oil and metals.

The big volume moves were in iron ore over recent months – Chinese traders imported 65 million tonnes in September, the second highest level on record, according to ANZ. The iron ore play may have a way to go before the trend is well established. ANZ and NAB see the question being whether this volume of imports is accounted for by re-stocking or an underlying improvement in demand. Rising bulk freight rates over the past six weeks suggest the bullish trend will have flowed into October but if it's restocking, rather than a material improvement in demand, that trend will slow in November. NAB notes spot iron ore prices have bounced back almost 40 per cent from lows in early September and appear to have settled around US$120 per tonne (CFR), consistent with the level where marginal Chinese production is thought to become unprofitable. Economic indicators suggest that demand conditions in China, and other parts of east Asia for that matter, have started to improve and NAB expects re-stocking may pick up again this month ahead of the winter. These factors should help support iron ore prices over coming months.

ANZ suggests most of the recovery in iron ore is coming from opportunistic arbitrage trading and steel mill re-stocking. This is where iron ore and coking coal price movements diverge on the journey to the steel mill. Coking coal pricing has been a lot less positive than iron ore, despite operating in the same end-user market. ANZ suggests lack of liquidity in the coking coal swaps market has meant investor interest has been much lower. Moreover, trade data shows Chinese coking coal imports falling by more than half in the past three months compared to a 10% increase in iron ore imports. Along these same lines NAB believes a convincing recovery in coking coal prices is being hampered by uncertainty over steel demand and conditions in the steel market are expected to remain subdued for some time.

Oil prices are expected to lift, having been pressured as the markets became concerned about the potential impact of Hurricane Sandy on demand. ANZ also expects firming prices in the next couple of months as a pick up in seasonal demand and a less volatile US equity market convinces funds to re-position on oil. ANZ notes crude looks cheap compared to other commodity markets, haven fallen an average 5% over October.

While urging caution over base metals because of heightened volatility, ANZ expects to see copper prices head back towards September’s highs near US$8,400 as the market pre-empts a bounce in China's economy. Aluminium is likely to remain choppy for the rest of the year and ANZ sees near term risks of prices testing down towards US$1,870 a tonne, and possibly lower, as the market contends with over-supply. By the very end of the year the analysts believe prices will start to push towards US$2,160. Nickel also has some scope to test lower levels, but less so than in the case of aluminium, and ANZ see a firm floor under the market at US$15,500 a tonne.

US dollar strength, particularly against Brazil's real, is likely to remain a negative factor on several agricultural fronts. Brazil is a major supplier of sugar, corn and soybeans and this creates a strong incentive for local producers to sell aggressively into global markets. ANZ notes Brazil’s October export volumes broke monthly records for corn and sugar and, with high prices existing for these commodities, any rationale for a rally is hard to find. Even with the 10% correction in grain and oilseed prices in recent months, prices are still 30-40% above levels of just six months ago. At present, Brazil sugar stocks are at a seasonal peak and are estimated to be around 5-year highs.

In the cut and thrust of demand and supply fundamentals gold retains its safe haven status. NAB and ANZ agree that continued central bank buying, and a weak longer-term dollar outlook, are likely to support prices. ANZ expects gold will end the year at US$1,780 an ounce and peak late in 2013 at around US$1,890 an ounce. Morgan Stanley, meanwhile, has posed the question of why, with the price of the precious metal well supported, are gold stocks so weak? The broker flags an opportunity for gold equities to close the 20% discount to the gold price that has opened up over the past nine months. The gold miners, as represented by the All Ords Gold Index, are down 21% over the past 12 months. By contrast, the spot gold price in US dollar terms is down just 2%. 

In Morgan Stanley's view, there have been several factors involved in creating this disparity, including operational underperformance from the miners which has contributed to a migration from equity to physical (ETFs) exposure. Also, many of the gold miners are mid and small caps, which are considered more risky propositions in the current conservative environment.The broker does highlight a high correlation between operational stability and the gold price movement, citing Regis Resources ((RRL)) and Silver Lake ((SLR)) as examples where a positive gold price correlation may indicate stability.
 

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