Outlook: Will the commodities price rally last?
Commodities prices began to rally at the beginning of Q2 after hitting rock-bottom in Q1, raising the question of whether this represents a turnaround in the downward trend that began in Q3 2014 or just a temporary increase. Analysts agree that while commodities prices are unlikely to undershoot the lows registered at the beginning of the year, the formation of bottoms could occur in the coming months. The Consensus view, however, is that the nascent recovery is here to stay, but its pace is expected to be slow and uneven across different commodities. Moreover, analysts reckon that—in the near and medium term–strong price corrections are likely since part of the recent rise is being driven by shifting investor sentiment and speculative trades. In the long term, analysts concur that commodities prices will rise due to fundamental factors, i.e. stronger demand and falling oversupply.
Looking at the individual commodity groups, the fledgling recovery in energy commodities prices, led mainly by oil, was triggered by a reduction in production. The price reversal in base metals was not due to further production declines, but as a result of higher demand. Risk aversion and the resulting search for safe havens provided tailwinds to prices of precious metals, in particular gold. Finally, the moderate increase in agricultural prices was influenced by disruptions in supply due to harsh weather conditions in some parts of the globe and higher demand.
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ENERGY | Supply outages in oil sustain the price rally
After a prolonged slump, energy prices continue to recover. In mid-May, crude oil prices for both Brent and WTI climbed nearly 70% from the multi-year lows seen on 20 January and moved closer to USD 50.0 per barrel. Despite the fruitless negotiations between the world’s major oil producers in Doha on 17 April to freeze production, a sustained recovery in oil prices has been mainly supported by a decline in crude oil output. According to recent data released in May, U.S. crude production has already fallen by 800,000 barrels per day from the 9.6 million per day peak registered last year. In addition, supply outages, around the world and lately in Nigeria and Kuwait have added to the evidence that oil production is declining. Moreover, low prices continue to bite on high-cost producers’ margins and capital investment levels. Moreover, in May, wildfires in Alberta, where many of the workers and support infrastructure related to Canada’s oil sands production are located, are expected to disrupt output, although temporarily as there are no reports of damage to facilities. At the same time, analysts believe that market participants remain cautious regarding the impact on prices of the return of Iranian oil exports, which was probably overestimated.
In a recent report, the EIA said that it expects non-OPEC crude oil output to fall by 0.7 million barrels per day (mbpd) in 2016 and by 0.2 mbpd in 2017, with most of the decline occurring in the U.S. For OPEC countries, the Agency expects crude oil production to increase by 0.9 mbpd in 2016, with Iran accounting for most of the increase. For 2017, the EIA sees OPEC producing an additional 0.7 mbpd. On the demand side, the Agency expects global consumption of oil and other liquid fuels to increase by 1.4 mbpd in 2016 and by 1.5 mbpd in in 2017. China and India are seen as the main drivers of consumption.
Despite the unsuccessful Doha producer talks, increased oil supply outages have tightened the market in recent weeks, leading to price rally for the hydrocarbon. The rally in oil prices, and, consequently, in energy prices, is expected to prevail in the coming weeks as there are increasing signs that output is falling among producers with higher costs. Energy prices, in general, are expected to rise 12.4% year-on-year in Q4 2016, with the outlook skewed to the upside as analysts hiked the forecast from the 11.1% increase expected last month.
BASE METALS | Prices rise in Q2 due to fundamental factors
Following the sharp decline in Q1, prices for the base metals picked up in recent weeks. The gain was the result of fundamental factors, including a pickup in demand from China—due to a recent increase in heavy construction in the country—as well as a relatively-weak U.S. dollar and improved market sentiment. Analysts believe that, going forward, the recovery in base metals prices will continue, but at a very slow pace. High volatility has been observed in some markets, namely in aluminium, copper, iron ore, lead and nickel. According to analysts, volatility was due to corrections that have removed some of the speculative froth that accumulated in the past weeks. Iron ore was in the spotlight last month, as the price for the commodity peaked above USD 70 per metric ton on 22 April. That said, prices for iron ore fell sharply following that peak, shedding about 20% by mid-May. Analysts suggests that the pullback reflects rising port stocks in China and tighter restrictions on speculative activity in the commodity market in that country.
Following the deep lows registered at the end of 2015 and beginning of 2016, analysts see base metal prices rising, albeit timidly, toward the end of this year. Further output cuts and a slow increase in demand will support prices and will cause them to increase by 4.2% year-on-year in Q4 2016. This month’s forecast was revised up from the 3.6% rise projected last month.
AGRICULTURAL | Prices for agricultural raw materials continue flying low
Prices for most agricultural commodities extended their losses and continued to decline at the outset of the second quarter. Corn, wheat and soybeans were the few exceptions. Following the release of the U.S. Department of Agriculture’s report on Prospective Plantings, the price drop in corn and wheat stabilized whereas prices for soybeans increased. According to the report, the planted area for corn is expected to increase by 6% this year relative to 2015, while the planting areas for soybeans and wheat are expected to decrease. The generalized price rout in agricultural commodities in Q1 and the beginning of Q2 is mainly explained by high inventory levels which offset the impact of adverse weather conditions. Moreover, prices for raw materials have not seen a substantial increase in recent weeks due to expectations that global production will increase this year, while consumption is projected to remain largely unchanged.
Risks associated with the arrival of La Niña—unusually cold temperatures in the equatorial Pacific Ocean—in the second half of the year are likely to provide support to prices for agricultural commodities this year. However, governments’ growing engagement in farm support policies will maintain downward pressure on prices. Meanwhile, the evolution of energy prices could also present upward and downward risks to the price outlook for agricultural commodities. Forecasters surveyed this month expect that agricultural prices will increase an average of 5.1% year-on-year in Q4 2016, which was revised up from the 4.8% increase expected last month.
PRECIOUS METALS | Risk aversion continues to drive rally
Prices for precious metals, led mainly by gold, rose in Q1 and the rally persisted in Q2 due to strong investment demand and a sharp increase in risk aversion, which prompted investors to search for safe-haven assets. Up until April this year, physically-backed gold Exchange Traded Funds (ETF’s) had expanded by 24% or nearly 350 metric tons, meaing that around a third of global mining output has flowed into gold ETF’s. In contrast, total ETF holdings fell by 140 metric tons in 2015 as a whole. Gold prices have been trading lower in recent days despite disappointing U.S. unemployment data for April. Also, physical buying slowed recently following the Akshaya Tritiya Hindu festival, which took place on 9 May. Meanwhile, the World Silver Survey 2016, released recently by the Silver Institute, showed that demand for the metal was strong in 2015, bolstered by record demand for jewelry and for investment coins and bars. Moreover, the Institute reported that silver demand for solar panels in China increased a healthy 23% in 2015 and that total supply declined 4% as mine production stalled.
Following the strong rally seen in Q1, precious metals prices are expected to continue increasing. The outlook for precious metals remains positive and analysts project that prices will rise 9.0% annually in Q4 2016. This month’s projection was revised up from the 6.7% increase that analysts had expected last month.
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