OUTLOOK | Debriefing the impact of Brexit on commodities markets

August 9, 2016

The impact of the Brexit vote on global markets and the world’s economy has prompted analysts and market participants to assess both the nature of the shock and the cyclical context in which it occurred. The result: the Brexit vote was an idiosyncratic UK shock that came at a juncture in which the global economy has failed to deliver strength. They see the knock-on effects to economic growth in the UK beginning to emerge only later this year and the overall drag from this shock to the global economy is expected to be moderate. However, the latter still depends on a number of factors that remain to be seen. In our latest Major Economies Consensus Forecast, the economic analysts we surveyed cut the 2016 GDP growth projection for the global economy by 0.1 percentage points to 2.6%. They also concluded that risks remain tilted to the downside due to the potential political reverberations that could magnify volatility in global financial markets and the amplification of stress via an impact in confidence.

In the second quarter of this year, prices for all raw materials rallied, rebounding from a deep plunge in Q1. However, the result of the UK vote to leave the EU had a substantial impact on several markets at the end Q2 and the beginning of Q3. Prices for energy commodities, particularly for crude oil, took a hard hit, mirroring the developments of other risky assets. Meanwhile, safe-haven commodities were in high demand, while base metals prices were surprisingly solid, whereas prices for agricultural raw materials showed mixed results. Even though negative sentiment will continue to weigh on prices for now as well as in the near term, clients should not underestimate the current market fundamentals: capital expenditure cuts and increased production efficiencies continue to act a key drivers in shifting supply and demand balances. Unless there is a full blown European recession—which is not the baseline scenario for the vast majority of analysts—Brexit’s impact on global commodities demand growth is expected to be moderate over the course of this year and next and the Consensus among analysts is that the aftermath of the Brexit vote will not substantially alter the view of market balances. If anything, greater volatility and downward pressures on prices are likely to occur. Against this backdrop, forecasters polled this month by FocusEconomics expect that prices for most commodities will continue to rise throughout the year and increase at a faster rate next year. Commodities prices are expected to increase 7.0% year-on-year in Q4 2016, which is an upward revision compared the 6.2% rise that analysts predicted last month. Throughout 2017, oil prices are expected to continue rising and in Q4, prices for raw materials are projected to increase 7.1%.

ENERGY | Oil markets are on track to tighten up in H2 despite Brexit jitters

Prices for energy commodities—driven mainly by oil, oil products and natural gas—rallied in the second quarter this year, bouncing back strongly from the ultra-lows registered in January. Oil prices have rebounded from a 13-year low of below USD 30 per barrel in January due to a streak of supply disruptions across the globe and lower U.S. crude oil output. However, gains stalled following the Brexit vote. The UK’s vote to divorce the EU triggered a sentiment-driven sell-off across global asset classes and oil prices dropped 5% in the aftermath of the referendum. The UK’s Brexit vote has provided analysts and market participants a timely reminder of how macroeconomic risks can generate downside pressures on oil prices.

Whether the implications of Brexit will be local, regional or global remain to be seen. The majority of analysts still consider that the baseline scenario for this year and next is that Brexit will have a substantial impact on the UK’s economy, while only a modest effect on global growth. Data shows that the UK represents just 1.6% of total global oil demand, which means that a Brexit should not affect meaningfully the oil market. Moreover, analysts agree that oil markets remain on track to tighten up in the second half of 2016, despite short-term concerns related to the Brexit vote. Unlike in the first half, when the market rebalancing resulted in part from a surge in unplanned outages, the market tightening in the second half is seen to be driven by structural, rather than temporary, factors.

That said, although some analysts say that the long-awaited rebalancing in crude oil markets is under way, short-term risks associated to the Brexit—a strong U.S. dollar, low risk appetite and uncertainty, among others—will dampen a fast recovery in prices. Prices for energy commodities are expected to rise 17.3% year-on-year in Q4 2016, which was revised up from the 15.5% increase expected last month.

BASE METALS | Weathering the Brexit storm

In the first half of the year, the evolution of base metals prices was positive, but lackluster. As with prices of many other commodities, base metals prices plummeted at the beginning of year, reflecting the Chinese stock market crash in early January and concerns regarding the health of China’s economy. However, prices bounced back and began to rise, albeit at a slow pace throughout the second quarter. The slow rise in base metals prices was mainly the result of a scale back in investment that caused production cuts, signs that China’s economy has stabilized and oversupplied markets. Then, the UK surprised the world on 24 June, when it voted to leave the EU, causing renewed volatility. That said, compared to developments in other markets, base metals were surprisingly resilient. Base metals benefited from the rally in oil prices in the second quarter and received support from an accommodative global monetary policy and from the fiscal and monetary stimuli in China. Looking at individual metals, modest gains were cemented in aluminium, lead and nickel. Zinc was the best performer, while oversupplied markets continue to add downward pressure on copper prices. That said, prices for iron ore were highly volatility in the first half of the year, with prices plunging toward the end of June, shedding all the gains made in the previous two months.

Looking into the second half of the year, the strength of the stimulus measures applied in China in Q1 is expected to be scaled back, although analysts still think that fiscal policy will remain accommodative. Meanwhile, the global economy, with an expected 2.6% growth rate this year, is facing downside risks in response to the Brexit. These risks for the base metals markets mean a potential drop in household spending and, particularly, in investment. However, while the baseline scenario is for an economic contraction only in the UK toward the end of this year and a broad-based recession next year, the UK itself is a small market accounting for less than 1% of the world’s base metals consumption. Therefore, any economic slowdown in the UK will have a negligible impact on the supply-demand balances. This, in turn, explains why base metals have shrugged off the Brexit shock thus far. A high-risk scenario would be that contagion across Europe could make Brexit a bigger issue as the EU alone represents about 15% total global demand. However, how likely this high-risk scenario actually is should become clearer in the months to come.

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 metal prices to increase by 3.5% year-on-year in Q4 2016. This month’s forecast was revised down from the 3.8% rise projected last month.

PRECIOUS METALS | NIRP, ZIRP, QE and Brexit remain positive drivers

Negative Interest Rate Policy (NIRP), Zero Interest Rate Policy (ZIRP) and Quantitative Easing (QE) have been the fundamental factors that fueled precious metals prices—an asset class often criticized as zero yielding—in the first half of this year, with the UK’s vote to leave the EU driving prices even higher. Results of late show that the fallout from the UK’s Brexit vote continues to dominate market sentiment, which gave gold’s rally another push in recent weeks, confirming gold’s status as a safe haven investment. Unlike some other perceived safe have assets, like the Swiss franc, the Japanese yen, and government long-term bonds, gold is not subject to risks related to government intervention. Data showed that, after three years of liquidation gold ETFs turned net buyers again so far this year, adding 476 tons to holdings. In addition, long positions in the COMEX market remain at all-time highs. Silver prices also rallied in in the second quarter in a catch-up move with gold, which prompted the gold-silver ratio to drop to a two-year low. This is reassuring to investors’ view of silver as good proxy for the yellow metal. Meanwhile, platinum and palladium also benefited from the gold rally and are expected to continue rising in the second half. However, unlike gold and silver, the outlook for platinum and palladium is more subdued. This is due in part to the ample above-ground stock of platinum that will continue exerting downward pressure on prices and the absence of investment interest on palladium.

Investment demand was the key driver behind a surge in precious metals prices in the first half of the year and is expected to continue providing support in the second half against an uncertain macroeconomic backdrop, financial market volatility and a more dovish outlook for U.S. interest rates. 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, which, in turn, has weakened in response to high prices. Jewelry is still the single largest demand source of gold. Demand for gold (and silver) jewelry, especially in China and India—the biggest markets for bullion—is highly price sensitive and, therefore, this two key buyers are not as present now as they were at the outset of the year. Against this backdrop, the outlook for precious metals remains positive and experts project prices to rise 15.3% Q4 2016 over the same period last year. This month’s projection was revised up from the 10.5% increase that analysts had expected last month.

AGRICULTURAL | Strong fundamentals support positive view

Prices for agricultural raw materials experienced a broad-based decline at the beginning of the year and rebounded strongly in the second quarter, led mainly by a surge in the prices of soybeans and sugar. These two top performers in Q2 were followed by coffee, corn and cotton. However, part of the gains recorded in the past two months were erased by the market shock caused in the aftermath of the Brexit vote. The outcome of the referendum in the UK affected notably agricultural commodities such as cocoa, corn, soybeans and wheat.

The most likely scenario for agricultural commodities in the coming weeks is of heightened volatility. However, market fundamentals remain robust: demand remains healthy and supply is constrained as a result of weak output, crop failures in Brazil and Argentina and planted acreage reviews in the U.S. These factors reinforced analysts’ view that inventories will continue falling in the coming quarters, hence supporting prices. Meanwhile, June was marked by two unexpected events. Firstly, that the prospects of a heat wave in the U.S. Midwest did not materialize, and, secondly, the U.S. Department of Agriculture’s (USDA) planted-acreage review did not show the expected migration of planted acreage from corn to soybeans. Consequently, after the report was released soybeans prices surged, whereas prices for corn plummeted. Analysts suggest that the USDA’s latest estimate indicates that the combined planted acreage for corn and soybeans in America will be the largest in history. Hence, the long-term prices for these two crops are expected to decline. Meanwhile, the increase in sugar prices persisted in June, which continued to reflect the change in the global balance. The balance now shows deficit, following five years of excess supply. Analysts also suggest that the correlation between sugar prices and the Brazilian real is no longer meaningful when the balance turns into deficit.

Against a backdrop of still healthy fundamentals and the gradual transition from the El Niño weather phenomenon to La Niña toward the end of this year, analysts expect that agricultural prices will increase 10.1% year-on-year in Q4 2016, which was revised up from the 7.2% increase expected last month.

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