Commodities | Sep 29 2015
-Low US rates prolong volatility
-Bulks hardest hit from China slowdown
-Emerging markets not taking up slack
-Issue for oil is looming Iran supply
-Profitable arbitrage in sorghum, barley
By Eva Brocklehurst
Outlook
Energy, industrial metals and agricultural products remain oversupplied, Citi observes, because of a sluggish world economy as well as the over-investment in developing new supply in the last decade. The broker expects Chinese economic stimulus will lift growth by the end of the year and this should have a positive impact on energy, industrial commodities and bulks, with the exception of iron ore, where new supplies are likely to continue to dampen prices even if steel demand rises.
Nevertheless, a continuation of very low interest rates in the US, which has caused a significant amount of the commodity price volatility in the past two years, as capital flees in the search for yield, should also prolong that volatility. Chinese growth prospects, and the extent of any downturn, remain the key to the outlook.
If the world's second largest economy weakens then demand could fall further and pull prices down. The bullish potential for prices, other than a Chinese rebound, lies in supply disruptions in oil from Iraq, Nigeria or Venezuela and the unfolding El Nino impact on crop production.
Few commodities, if any, have escaped the recent rout. Citi observes, even if China contagion fears are overdone and a global recession does not evolve, growth in China will not continue at its former robust pace and no other emerging market is likely to take up the slack. Moreover, the US Federal Reserve surprised the market with its dovish tone in September, heightening expectations that rates would not begin to rise until 2016.
Citi expects bulk commodities will be hit the hardest by the weaker demand from China followed by base metals. International steel, aluminium and petroleum product markets should remain under pressure as China continues to export its surplus. Macquarie concurs. In many markets there has simply not been enough pain inflicted to accommodate the drop in demand and break the cycle where prices continue to grind lower.
Macquarie, for the first time since 2013, is slightly more comfortable that Chinese demand may have hit a cyclical low. Nevertheless, ex China, the emerging markets are becoming a larger concern, following currency moves and the flight of capital.
Another analyst. Another bear. ANZ analysts suggest that while prices did recover modestly in September, this may only be a short-term reprieve. Most emerging market economies are seen moderating from high rates of growth and financial risks are rising after a period of rapid leverage. Brazil and Russia are in recession and China's growth is expected to slow to 6.0% over the next two years.
The rate of Chines infrastructure spending is also behind schedule with only 30% of the target spent in the year to date. While some more expenditure is expected as the year draws to a close, the analysts observe after a visit to China, that the private sector, where a higher-than-normal level of investment is being channelled, appears to be finding little reason to proceed quickly.
Bulks
Macquarie has lowered forecasts across the board to reflect current market conditions, lower energy prices and new FX estimates. Long term prices for half the commodities the broker covers have been downgraded, particularly nickel, steel and iron ore.
Iron ore, manganese ore and the coals – thermal and coking (metallurgical) – appear set to sustain many years of sufficient supply and Macquarie lowers forecasts by 10-20%. The ANZ analysts suspect iron ore prices could test US$50/t with Chinese steel output slowing at a time of rising seaborne supply and are likely to remain flat for the next two years.They expect some price relief in thermal coal towards the end of the year as the northern winter sets in.
Base Metals
Macquarie observes that nickel is the prime example of a base metal suffering from the weakness in demand, with high inventories and weakness in stainless steel. Supply cuts in aluminium are occurring but the broker finds minimal potential for a recovery in the price over this decade. Copper and zinc are sustaining lower future mine supply but, given current market conditions, are also unlikely to recover much ground.
The ANZ analysts suspect that in the case of copper, prices may have formed a base after Glencore decided to close 400,000 tonnes of capacity in Africa. Aluminium exports from China have eased but volumes remain at elevated levels.
Oil
The oil outlook is bearish and the return of Iran to the market early next year will add to the supply. US production may be falling, particularly shale, but OPEC production is rising and non-OPEC remains strong as well. Citi expects prices to grind lower in the fourth quarter and the broker's economists have added a bearish risk to the mix by putting the odds of a global growth recession at over 50%.
A balanced market in oil is considered unlikely until the end of 2016. ANZ's analysts also expect oil to stay lower for longer. The surplus is expected to continue for the next 18 months although the severity of the oversupply is gradually declining. In terms of Iran, they note that opposition to the deal in the US is strong and this may mean any relief to sanctions could be pared back.
Platinum
The scandal involving Volkswagen and the fiddling with pollution controls on its cars could affect the platinum group metals, which are used heavily in emissions control systems. Brokers believe, while it is too early to tell the extent of the implications, the longer-term impact on diesel engines could be significant. Macquarie expects further pressure on the platinum price as a result of the scandal.
Grains
ANZ analysts observe that Chinese grain prices have been at elevated levels compared with global prices, providing an opportunity to import grain at the expense of domestic supply. Import quotas for corn, wheat and rice are controlled, which prevents any leakage of China's price support to the global market. This is not the case in the unregulated feed markets of sorghum and barley.
The analysts highlight the profitable arbitrage in this markets has meant imports have jumped sharply. Feed grain stocks are already high in China and government losses are increasing, with reports of storage and quality constraints. However, a repeat of the surge in imports – in the last 12 months Chinese imports of Australian barley rose sharply – is unlikely over the next year and China is not expected to have the same influence on prices as it did in 2014.
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