Why Won’t Commodities Rise?

This story features RIO TINTO LIMITED. For more info SHARE ANALYSIS: RIO

– Commodities have surprised to the downside in early 2013
– Q2 should see higher prices, but no fireworks should be expected
– Supply levels still too high (for the most part)
– Europe represents major downside risk

By Andrew Nelson

It’s been a funny year so far for commodities, which as a group are continuing to struggle to post any sort of sustained price gains.

Commodity analysts at  Danske Bank note that, even before this week's sell-off across the spectrum, energy, metals and grains prices were lower than they were at the start of 2013, begging the question: when will commodities begin to perform?

Danske sees three main reasons for this underperformance and while the pressure is expected to ease starting over this quarter, the bank doesn’t expect to see commodities catching up with equities any time over the course of the current half year.

Firstly, the slow improvement in China has not been very commodities intensive. There was also quite a bit of hope pinned on an increase in buying once the Chinese Lunar New Year holidays were in the rear view mirror, but it never happened.

At the same time, while US growth may have shifted into a higher gear, a soft patch is coming (or may even be here) given the heavy federal budget cuts that have been brought into play by this sequester nonsense. As a result, commodities have not seen the positive demand backdrop that is needed to lift prices higher.

Next on the list is everyone’s favourite topic, Europe. First we had Italy and its inability to choose a government, be it pro-bailout or anti. Then the Cyprus crisis followed right on Italy’s heels. Suffice it to say confidence in a European recovery remains at fairly low levels. Tied directly to this is speculation as to when the Fed will pull the plug on current easing.

These issues not only bring about the investor’s worst enemy, uncertainty, it has also caused a steady decline in the EUR/USD. This in turn has weighed on commodities from a denomination perspective, which is compounding the whole uncertainty/risk theme.

Danske does note an interesting phenomenon that all this has brought about. Speculators have moved though crude, copper, gold and corn of late, and they are cutting a wide swath. The good news here is that Danske sees this setting the stage, with not much now in the way of bullish news needed for prices to start recovering.

Lastly, there’s the biggest enemy of commodity prices, too much supply. Like in oil, where OPEC prices keep nudging higher despite the supply being added by US shale production. The Saudis have cut production, but they’re not the only guys out there with oil and everyone else is churning it out. OPEC supply is still running above 30mb/d.

Copper production has continued to lift on the wide held belief the Chinese would accelerate imports. But it hasn’t. LME stocks have surged to post-crisis highs and future supply prospects are way too promising. Nearer-term, the International Copper Study group now expects the copper market to move into surplus this year. It remains debatable whether this remains the case following Rio Tinto's ((RIO)) production disruption in the US.

The bank has moved across its forecast universe and pretty much trimmed forecasts across the board. That said, Danske still expects to see a lift in commodity markets through the current quarter, as the underlying cyclical outlook continues to improve. Europe will be the key to this. If the ECB goes for a rate cut, or if Italy remains without a government, or even worse, if the debt crisis resurfaces, then say goodbye to you near term commodity hopes, says Danske.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms