The recovery in commodities prices observed in the first half of the year is starting to sputter. Growing concerns of weak global economic growth, volatility in financial markets following the Brexit vote and still high inventories are keeping investors and consumers cautious about a wide range of commodities. That said, the current low-price environment will weigh on producers in the coming months, which in turn will provide support for prices toward the end of the year.
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Commodities prices rallied in Q2, but the recovery halted at the beginning of Q3 due to a combination of factors. Demand from China for some commodities—particularly energy and base metals commodities—slowed, following stronger-than-expected industrial activity earlier this year. The aftermath of the Brexit vote also had a considerable impact on global commodities markets at the outset of Q3. Prices for energy commodities, led mainly by crude oil, took a severe hit in the aftermath of the vote mirroring the performance of other risky assets. Conversely, precious metals were in high demand as investors stampeded into safe haven assets. Base metals prices remained subdued, while prices for agricultural commodities faltered due to high inventories.
Although negative sentiment will continue to weigh on prices in the near term, market fundamentals are expected to remain solid: capital expenditure cuts and increased production efficiencies continue to act as key drivers in shifting the supply and demand balance. Moreover, the Consensus view among analysts is that the aftermath of the Brexit vote will not substantially alter the opinion on market balances and, once the volatility dissipates, market and macroeconomic fundamentals are expected to be positive drivers for commodities prices toward the end of this year and into next year. Against this backdrop, forecasters polled this month by FocusEconomics expect that commodities prices will increase 8.0% year-on-year in Q4 2016, which marked an upward revision compared the 7.0% rise that analysts predicted last month. Throughout 2017, oil prices are expected to continue increasing and in Q4, commodities prices are projected to rise 6.1%
ENERGY | Oversupply weighs on energy prices
The rapid gains observed in energy prices in Q2 stalled early in Q3 as demand was tepid and markets remained oversupplied. Crude oil prices continued to fall at the beginning of Q3, reflecting concerns over the persistent global supply glut and signs of sluggish demand as well as uncertainty following the Brexit vote. In the beginning of August, Brent Crude Oil prices lingered near the USD 40-per-barrel mark, while WTI Crude Oil prices fell below USD 40 per barrel for the first time since mid-April. According to experts, the oil market remains in a resolution phase, which means that low prices are cutting investment and driving a gradual reduction in supply which, in combination with steady, albeit weak, demand, encourages a tendency toward drawing down excess inventories. Crude oil prices have also been affected by oversupplied gasoline and other refined products markets. The silver lining of energy commodities’ current performance is natural gas. Prices for Henry Hub Natural Gas have recently been boosted by a decline in inventories and above-average temperatures. Recent developments in the U.S. showed that balances in the natural gas market have tightened due to increased power generation.
Few analysts dispute that energy prices, led mainly by crude oil, will eventually rebound. However, the timing remains uncertain. Nonetheless, analysts agree that rebalancing in crude oil markets is under way and that demand in India will pick up toward the end of the year, while it will stabilize in China. However, substantial noise persists as a result of the UK’s decision to leave the EU. Risks associated to Brexit are a strong U.S. dollar, low risk appetite and uncertainty, among others, which have the potential to dampen the recovery in prices. Forecasters predict that prices for energy commodities will rise 18.2% year-on-year in Q4 2016, an upward revision from the 17.3% increase expected last month.
BASE METALS | Prices will be supported by supply constrains
After plunging in Q1, base metals prices bounced back in Q2, but developments at the outset of Q3 were lackluster. Supply-side constrains and falling inventories at the beginning of the second half of the year have helped buttress prices, yet weak Chinese demand added to downward pressure on prices. Although the Brexit vote sent shockwaves throughout global financial markets and prompted volatility in base metals prices, they were surprisingly resilient in comparison to other commodities. Results of late are the recent gains in nickel, zinc and iron ore, which reflected improving sentiment towards investment, a further relaxation in global monetary policy and speculation of further stimulus in China. Meanwhile steel prices in the U.S. and European markets stabilized recently after having rallied strongly since Q1. Steel prices have achieved strong gains this year in these two markets as U.S. and European authorities decided to impose duties on steel imports coming from six countries, including China, due to a dumping investigation.
The global economy is facing downside risks in response to Brexit. The risks for the base metals markets are a potential drop in household spending and, particularly, in investment. The baseline scenario is for the UK to experience an economic contraction toward the end of this year and a broad-based recession next year. As the UK is a small market accounting for less than 1% of the world’s base metals consumption, an economic slowdown would have a negligible impact on the supply-demand balances. This explains why base metals have shrugged off the Brexit shock thus far. A high-risk scenario would be for contagion across Europe to make Brexit a bigger issue as the EU represents about 15% total global demand.
Analysts expect base metal prices to rise, although timidly, toward the end of this year as further output cuts and a gradual increase in demand will support prices. Analysts expect base metals prices to increase by 4.1% year-on-year in Q4 2016. This month’s forecast was revised up from the 3.8% rise projected last month.
PRECIOUS METALS | Investor demand expected to remain strong
Investor demand for precious metals was strong in the wake of the Brexit vote and growing uncertainty regarding the coming U.S. presidential election is keeping demand for safe havens high. The backdrop of negative bond yields, a protracted loose monetary policy in Europe and Japan, and speculation that Federal Reserve will postpone an interest rate increase will also continue propelling investor demand and provide further support to precious metals prices. The latest push in demand for safety came from terror attacks in France and the military-led putsch in Turkey.
However, the rally in precious metals, particularly in gold, is likely to be limited. Investment demand for safe havens has replaced previous strong physical demand from emerging markets—particularly Asia. High prices for precious metals have caused a slowdown in physical demand, prompting a drop in purchases of jewelry, which is the single largest demand source of physical gold. Demand for gold (and silver) jewelry, especially in China and India—the biggest markets for bullion—is highly price sensitive, therefore the presence of such buyers has waned since earlier in the year. Against this backdrop, the outlook for precious metals remains positive and experts project prices to jump 20.9% in Q4 2016 over the same period last year. This month’s projection was revised up from the 15.3% increase that analysts had expected last month.
AGRICULTURAL | La Niña looms on the horizon
After a weak start to the year, agricultural commodities prices rose strongly in Q2, led mainly by a surge in the prices of soybeans and sugar. These two outperformers were followed by coffee, corn and cotton. However, part of the ground gained at the end of the first half was lost following the market shock in the aftermath of the Brexit vote. The outcome of the referendum in the UK notably affected agricultural commodities such as cocoa, corn, soybeans and wheat.
Prices for most crops have been affected by changes in the weather. The El Niño weather phenomenon of 2015/2016 has been the strongest on record, with temperatures in the central and east-central equatorial Pacific Ocean peaking at 2.3º C above seasonal norms. Temperatures have been falling since the peak in December 2015 and the latest data show that temperatures averaged just above normal in July. This drastic drop in temperatures suggests that the latest El Niño is likely to turn into a powerful La Niña. The La Niña phenomenon is associated with cooler-than-normal weather conditions along the North American west coast, and warmer, drier conditions in much of the southern United States. The strength of the phenomenon remains to be seen, but it definitely has the potential to impact worldwide weather conditions. Past La Niñas have stirred agricultural commodities markets, prompting mild price volatility and also wild roller-coaster rides. The risk of La Niña is significant, yet stocks of agricultural raw materials remain high, which means that significant swings in prices are likely to be contained. El Niño normally boosts bullish crops prices, while La Niña tends to be rather bearish. Analysts expect that agricultural prices will increase 11.2% year-on-year in Q4 2016, which was revised up from the 10.1% increase expected last month.