Commodities: Outlook: Commodity price increase set to moderate by year-end after rebound in Q4 2016
February 15, 2017
The outlook for commodity prices remains positive this year, supported by healthier global macroeconomic dynamics. After an expected 2.6% increase in 2016, global economic activity should experience a mild improvement this year and expand 2.9%. Against this backdrop, commodity prices are expected to increase 3.6% year-on-year in Q4 2017, though this will nevertheless mark a deceleration compared to the price growth in Q4 2016. This year’s rise in prices will be buttressed mainly by higher prices for energy, base metals and agricultural commodities. Prices for precious metals are expected to be the exception.
Prices for most commodities rose in the final quarter of 2016 from the lows registered earlier in that year. In Q4 2016, prices for the commodity complex surveyed in this report increased 13.2% year-on-year, supported by higher energy prices (+21.5% year-on-year), base metals (+15.4% yoy) and precious metals (+10.1% yoy). Conversely, prices for agricultural commodities fell 1.1% annually in Q4 2016.
Energy prices rallied strongly toward the end of 2016 supported mainly by higher crude oil prices, following the agreement of OPEC and non-OPEC producers to limit output in H1 2017. Base metal prices rebounded strongly in Q4 2016, reflecting tightening supply and still strong demand from China. Meanwhile, the strong rally in precious metals in Q3 lost momentum in the final quarter of 2016 as a result of higher U.S. interest rates and a strong U.S. dollar. Prices for agricultural commodities were lower in Q4 2016 relative to Q4 2015, although there were large variations among commodities.
Outlook remains positive on higher oil prices
The outlook for energy prices remains positive. Prices are projected to increase 11.7% year-on-year in Q4 2017 on the back of higher prices for crude oil and its derivatives. Moreover, Henry Hub natural gas prices should continue extending last year’s gains this year, but at a more moderate rhythm. Meanwhile, forecasts for uranium suggest that the price of the radioactive element will recover this year from the losses in 2016.
Crude oil prices, which have risen substantially following the news of OPEC’s formal agreement to cut production, will lead the improvement in energy prices and are projected to average USD 55.4 per barrel in Q2 2017 and to approach the USD 60.0 per barrel mark in Q4 2017. Analysts and market participants remain confident that the crude oil market will slowly rebalance in H2 2017, reflecting OPEC and non-OPEC production cuts and a gradual decline in inventories. However, full compliance among OPEC members—who have a poor record on this matter—remains key to reducing inventories at a time when global stocks remain stubbornly high. OPEC and non-OPEC producers agreed to reduce output by a combined 1.8 million barrels a day (mbd) for the first half this year and the agreement, the first one since 2008, could be extended for a further six months, should market conditions allow it. Meanwhile, the response from U.S. producers to higher prices will continue to be a key determinant for the future of the rebalancing in the oil market.
Outlook positive on improving sentiment and fundamentals
The outlook for most base metals also remains positive as the optimism seen at the end of 2016 will persist through most of 2017. Following a strong rebound in Q4 2016, prices for industrial metals are expected to continue rising strongly during the first half of this year and to moderate toward the end of the year. Analysts expect base metal prices to increase just 2.1% annually in Q4 2017, supported mainly by higher prices for copper, lead, nickel and zinc, which will compensate for subdued prices of aluminium and declining prices of iron ore and tin. Meanwhile, U.S. steel prices are projected to rise strongly in Q4, while steel prices in the European market are expected to drop.
Optimism in the base metal complex is the result of a tightening in most markets, especially those facing imminent resource constraints. The rebalancing reflects slowing investment, mine closures, environment constraints and policy developments, particularly in China, Indonesia and the Philippines. The largest gains are expected in zinc and lead due to mine supply constraints as a result of permanent and discretionary closures. Important gains are also expected for copper, nickel and tin.
However, China’s transition to a consumption-led economy from one based on investment and exports, together with its industrial reform and environmental concerns, is likely to slow demand for metals and keep prices more sluggish toward the end of this year. Upside risks to prices include stronger global demand, a slow ramping up of new capacity and global environmental constraints that could limit supply.
Higher energy costs will push up prices but a strong dollar weighs on the outlook
Agricultural commodity prices failed to rebound in the final quarter of 2016, dropping 1.1% year-on-year. Agricultural raw materials covered in this report had a bumpy ride in 2016 as the combination of bad weather conditions in some parts of the globe and record-high yields in other economies caused international prices to remain subdued. The outlook for agricultural commodities is a bit uncertain as volatility will persist in the coming quarters.
Prices for most agricultural products will receive support from a global reflationary environment, stronger economic growth and rising energy prices. Upward pressure may also come from the drawdown of inventories of most agricultural products this year after having accumulated stocks during a number of seasons in 2016. Commodities experts expect prices of the agricultural commodity complex to be volatile, but project that they will increase 6.7% annually in Q4 2017.
That said, risks are tilted to the downside as expectations of a persistently-strong U.S. dollar in 2017 and some ongoing volatility in exchange rates—particularly in emerging economies—should act as headwinds to a better performance in these commodities. Moreover, an uncertain weather forecast is driving analysts’ more conservative estimates at this stage. The presence of a weak La Niña in Q1 2017 will continue to influence regional weather anomalies and output. The weakness in the intensity of the weather phenomenon makes forecasting the impact more difficult. Going forward, agricultural commodities are expected to settle low for a 3.5% rise in Q4 2018.
Less positive outlook driven by U.S. monetary policy
Looking at 2017, precious metals prices are expected to perform poorly despite the many challenging events that could boost demand for safe haven assets. Precious metal prices are projected to decline 1.4% year-on-year in Q4 2017, mainly due to expected lower gold prices. Silver prices are seen rising mildly in Q4 2017, but its performance is expected to be poor, while palladium and platinum are forecast to end the year on a good note.
Precious metal prices, in particular gold and silver, experienced a rollercoaster ride in 2016, affected mainly by the events that shocked the world last year. Prices peaked in the summer of 2016 following the Brexit vote, but have since fallen in response to higher U.S. interest rates and a strong U.S. dollar. As expected, the U.S. Federal Reserve increased interest rates toward the end of 2016, with further rate increases expected this year depending on economic and financial conditions in that country. Physical demand for gold, platinum and silver was also weak last year, particularly in the world’s two largest consumers, China and India, given the metals’ elevated prices. Platinum physical demand, in particular, has been affected by the Volkswagen diesel emissions scandal, as the metal is mostly used in diesel catalysts.
Although upside risks to the outlook for precious metals are expected to come from political events and geopolitical tensions, strong physical demand from China and India, and mine supply shortfalls, prospects for the metals are less optimistic and will mostly be driven by U.S. monetary policy and its impact on the U.S. dollar’s performance. Traditionally, gold has performed well within U.S. hiking cycles as the yellow metal has always been seen as a hedge against inflation. However, prospects for higher interest rates in the world’s largest economy—which is close to enjoying full employment—will likely strengthen the U.S. dollar and hence affect investment demand for precious metals, particularly for gold and silver. Although investor demand for platinum will likely experience the same consequences as with gold and silver, platinum prices will benefit from stronger physical demand, given a tighter supply of the metal.