Commodities Economic Outlook November 2016

Will the commodity price rally last?

Commodities: Will the commodity price rally last?

November 8, 2016

Most commodity prices continued to increase at the beginning of Q4 after rallying for two consecutive quarters, despite the uncertainty in the global financial markets. The increase in prices in Q4 is mainly the result of two factors: first, supply shocks related to OPEC’s production agreement, mine closures and a drop in inventories for most raw materials; and second, a gradual improvement in demand stemming from greater confidence in the Chinese economy and improving global industrial production. In this month’s survey, analysts polled by FocusEconomics expect commodities prices to increase 9.0% in Q4 2016 from the same period last year, which contrasts the 26.7% plunge registered in Q4 2015.


Looking at the individual commodity groups, the outlook for energy prices, led mainly by crude oil, coal and natural gas, remains positive as a result of a gradual market rebalancing and expectations that OPEC will limit production. Base metal prices are expected to rebound in the final quarter of 2016 and continue rising throughout next year due to faster-than-expected mine closures. Prices for precious metals are predicted to stay high at the end of this year, as investment demand is seen remaining strong due to uncertainty regarding monetary policy and rising political and geopolitical risks. Finally, agricultural commodities prices are expected to rebound strongly in Q4 and remain on a gradual recovery path as many commodities in this sub-group remain subject to higher energy costs and supply conditions.


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Looking forward, forecasters see a more solid outlook for commodity prices next year supported by brighter prospects for prices of energy and base metal commodities. The Consensus view among commodities experts is that demand will strengthen next year and prices will rise 5.4% annually in Q4 2017.


ENERGY | What to expect in Vienna


Energy prices continued to rise in the third quarter and at the beginning of Q4, supported mainly by an increase in prices for coalcrude oil and U.S. natural gas. Coal prices surged during Q3, reflecting strong import demand and tightening supply in China, following restrictions on production aimed to reduce pollution. Crude oil prices rose mildly in the third quarter as a return to supply in Canada—following the wildfires in the spring—and higher production in Iran and Saudi Arabia offset the impact on prices from OPEC’s announcement of a deal to limit oil output. Furthermore, U.S. natural gas prices increased in Q3, buttressed by higher demand for air conditioning, declining production and increased exports to Mexico and South America.


OPEC’s announcement in Algeria to cap production at between 32.5 and 33.0 million barrels a day was clear: freezing production levels is necessary for stock draws to accelerate and prices to trend higher. The agreement should put an end to two years of unrestrained production, but important details, including target outputs for individual countries, are still to be decided and agreed upon at the upcoming 30 November meeting. Iran, Libya and Nigeria are likely to be exempted from the production cap due to earlier output losses, leaving Saudi Arabia and the economies of the Gulf Cooperation Council (GCC) bearing the burden. The decision by OPEC to abandon production quotas in favor of a market-share strategy in November 2014 and the recent announcement to limit production have led to a debate about OPEC’s effectiveness in managing the markets. Doubts about the cartel’s ability to effectively cut production when it next meets in November have intensified, as members outside OPEC have shown little sign of agreeing over where the cuts should fall.


There are legitimate reasons to remain skeptical about the agreement, but analysts believe that OPEC’s action could accelerate the ongoing market rebalancing process. Analysts surveyed by FocusEconomics expect energy commodities prices to increase 22.2% year-on-year in Q4 2016, which has been revised up from the 19.6% increase they forecast last month.


BASE METALS | China will slow demand


Base metal prices rose in Q3, marking a second consecutive quarterly gain, following six consecutive quarters of decline. Prices continued to rebound from the record lows recorded in the first quarter due to supply constraints, increasing demand and a gradual decline in inventories. Prices for iron orenickelleadtin and zinc have outperformed other metals as a result of substantial supply shortfalls, while the two largest consumed metals—aluminium and copper—have recorded only modest gains. Zinc is the base metal that has seen the strongest gains this year, totaling more than 50% since January due to ongoing supply tightness from mine closures and voluntary production cuts and strong demand from China, particularly in the steel-producing sector. Meanwhile, high nickel prices continue to receive support from the Philippine government’s suspension of mines for environmental violations.


China’s efforts to boost its infrastructure and construction sectors have been the main driver of demand for base metals this year. It accounted for over 50% of global base metal consumption in 2015. However, China’s transition to a consumption-led economy, together with industrial reform and environmental concerns, is likely to slow demand for raw materials and keep prices sluggish in the coming years. Analysts see base metal prices increasing 6.6% in Q4 2016 from the same quarter last year (previous month’s forecast: +4.9% year-on-year), which, if confirmed, will mark a rebound compared to the 28.7% decline registered in Q4 2015.


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PRECIOUS METALS | Monetary policy is the main driver


Following a strong increase in Q3, prices for precious metals, led mainly by gold, slipped at the beginning of Q4. The strong performance in Q3 reflected strong investment demand and safe-haven buying against a backdrop of uncertainty in the global financial markets and low interest rates in the developed world. However, the drop in prices at the outset of Q4 was due to investors’ response to speculation that the European Central Bank (ECB) may modify its bond-buying program, which is set to expire in March next year, and to growing expectations that the U.S. Federal Reserve will raise interest rates in December.


Meanwhile, the gold-silver ratio has fallen from a 23-year high of over 80:1 in March to around 70:1 at the beginning of November, which reflects improved risk appetite for industrial commodities. Silver prices have rallied strongly, boosted by resurgent physical demand due to strong photovoltaic production in China. Prices for palladium and platinum appear to have bottomed out at the end of October as these metals found strong buying interest within a context of lower mine output.


Various key central bank meetings will occur in the final quarter of the year, which are likely to be crucial in terms of their impact on bond yields and prices for these metals, as will be the results of the U.S. presidential election. Analysts’ baseline scenario continues to be a Clinton victory. However, the former Secretary of State’s lead over Donald Trump has narrowed in recent days, which suggests a tighter result and, consequently, higher financial market volatility. According to analysts, a Clinton victory would boost risk appetite in the near term, because it maintains the status quo. The outlook for precious metals remains positive and analysts project that prices will increase 18.6% annually in Q4 2016. This month’s projection was revised down from the 20.8% increase that analysts had expected last month. 


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AGRICULTURAL: Prices rebound on higher energy costs


Prices for most agricultural commodities rebounded at the beginning of Q4, following a generalized drop in Q3. The price performance of agricultural commodities varied considerably depending largely on their respective demand and supply conditions, yet the rebound observed at the beginning of Q4 is mainly the result of the impact of higher energy prices, since agriculture is energy intensive.


The outlook for agricultural commodities remains positive this year as analysts forecast a 5.0% year-on-year increase in Q4 2016. This month’s projection revised down from the 7.0% increase expected last month and mainly reflects the impact of higher energy prices—fuel, fertilizers and other energy costs—and the La Niña weather phenomenon. Even if La Niña intensifies, the impact is expected to be limited as most agricultural markets remain oversupplied. After a projected 5.0% year-on-year increase in the final quarter of 2016, prices are expected to slow substantially next year. Forecasters expect agricultural prices to rise 2.8% in Q4 2017.


 

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