Commodities: Commodity price outlook remains positive
March 15, 2017
This time last year, prices for most commodities were sitting near record lows, prompting investor sentiment to sour. Since then, prices have risen across the board and a renewed sense of optimism about demand for most raw materials comes against a better global macroeconomic backdrop and a host of commodity-intensive infrastructure projects. After a 2.6% increase in 2016, global economic activity should experience an improvement this year and expand 2.9%, supported by better developments in both developed and emerging economies. This, along with supply constraints for certain commodities, is driving positive sentiment and the outlook for prices. Following a strong 13.2% year-on-year increase in Q4 2016, prices for the commodity complex surveyed in this report are expected to extend their gains throughout this year and record a 3.8% rise in Q4 2017.
The worst is likely behind us and the fact that many commodity markets are still facing supply-side issues is adding to the optimism. However, to date many producers across most commodities have been largely unable—or unwilling—to react to higher prices, keeping a supply ramp up contained. Q4’s expected increase will mainly reflect higher prices for base metals, energy and agricultural commodities. Conversely, prices for precious metals, led mainly by gold, are projected to fall in year-on-year terms in Q4 2017.
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Energy prices rallied strongly in the final quarter of 2016, fueled by the agreement of OPEC and non-OPEC producers to curb oil output in the first half of 2017. Q4’s price gains were extended into the first quarter of this year, but concerns are growing that oil inventories remain high. Base metal prices increased strongly in Q4 2016, reflecting tighter supply and stronger demand. Prices for most industrial minerals continued to rise in Q1, although at a more moderate pace given uncertainty related to politics and policy, particularly policy out of Beijing. Meanwhile, precious metal prices have been under pressure in Q1 2017, following a strong rally in Q4 2016. Gold and silver prices received support from political uncertainty at the beginning of the year, but have corrected lower due to higher prospects of a March U.S. interest rate increase. Meanwhile, agricultural commodity prices fell annually in Q4 2016, but in reality each commodity that composes the aggregate traded on its own fundamentals, yielding different price outcomes.
OPEC compliance has exceeded expectations
Prospects for energy prices are positive. Analysts project they will increase 11.8% in Q4 2017 from the same period last year, mainly reflecting higher prices for crude oil and oil products—gasoline and gasoil. In addition, natural gas prices are seeing performing tremendously well throughout 2017 and they should continue extending last year’s gains. Meanwhile, forecasts for uranium suggest that the price of the yellow cake will perform erratically this year, and coal prices are forecast to decline from the highs seen at the end of 2016.
Initial OPEC compliance has exceeded expectations, with estimates indicating that cartel-wide production (aside from exempted members Libya and Nigeria) fell by about 90% of the agreed amount, far above the historical average of 60% following similar deals in the past. OPEC’s coordinated effort to curtail global supply has so far managed to put a floor under prices, which have been sitting modestly above USD 50.0 per barrel since the deal was announced at the end of November 2016. However, resurging U.S. shale output and still very high inventories have been dampening the upside and crude oil prices have fallen below the USD 55.0 per-barrel mark in recent days. Although higher crude oil prices in Q1 have resulted from the surprisingly high OPEC compliance, they remain stuck for now in a narrow band, kept in check by the shale industry and record-high inventories in the U.S.
Bullish sentiment persists for base metals
Panelists remain optimistic about the outlook for base metal prices. Following a strong rebound in Q4 2016, the increase in base metal prices is seeing accelerating during the first half of this year and moderating toward the end of the year. Commodities experts project the prices of base metals to increase 2.2% annually in Q4 2017. The price performance reflects higher prices for copper, lead, nickel and zinc, which will offset a weak increase in prices of aluminium and a decline in prices of iron ore and tin. Regarding steel, U.S. prices are projected to rise strongly in Q4 reflecting positive sentiment, while prices in the European market are expected to drop.
In recent weeks, base metal prices have corrected lower, settling in a more consolidated position. This mainly looks like a bout of anxious profit-taking in response to the strengthening of the U.S. dollar, ahead of the upcoming U.S. Federal Reserve meeting and also due to a somewhat disappointing speech from President Trump in Congress. That said, the latest U.S. manufacturing PMI data for February was strong, as was Chinese foreign trade data. These results suggest that economic activity in the world’s two largest economies remains healthy, which bodes well for base metal demand. As such, most panelists remain optimistic about the outlook.
Positive prospects for the base metal complex are the result of the rebalancing in most markets. The rebalancing reflects slowing investment, mine closures—major work stoppages in Chile and Indonesia will cause a substantial supply copper deficit—environmental constraints and policy developments, particularly in China. But, 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.
Rising U.S. rates and dollar are clouding the outlook
Expectations for higher U.S. interest rates and a strong dollar are posing headwinds for precious metals, in particular for gold and silver, despite significant political and geopolitical uncertainty. Precious metal prices are forecast to decline 0.5% annually in Q4 2017, on the back of lower gold and silver prices. Conversely, prices for palladium and platinum are expected to end the year on a good note, given stronger industrial demand for the metals.
Precious metals remain under pressure and, for this complex too, it is the prospect of a mid-March U.S. interest rate hike that has no doubt prompted investors to short gold and silver to reap the profits. In previous reports, we recalled that selling gold and silver was noted ahead of the two previous rate rises in December 2015 and December 2016, and after each rate increase, gold prices started to rally. This time, high uncertainty related to Brexit, European elections and the Trump administration will attract some safe haven demand and support prices somewhat.
Beyond gold’s weakness in investment demand, India’s demonetization efforts are having an impact on physical gold demand. According to experts, the elimination of high-denomination bills (INR 500 and INR 1,000) prompted individuals to use gold to transition shadow money back into the legitimate economy, thus reducing demand for the yellow metal. Demonetization also shocked economic activity in India, weakening demand for gold in any forms. India is the world’s second-largest purchaser of gold jewelry, and more than half of household savings are believed to be held in gold rather than more conventional bank deposits.
Politics, rather than weather, becomes main source of uncertainty
Agricultural commodity prices are expected to perform better this year, compared to last year. The outlook is positive overall and analysts see them rising toward the end of the year, although considerable differences remain among raw materials. Prices are projected to increase 5.5% year-on-year in Q4 2017, which will mark a rebound from the 1.1% drop seen in the same quarter last year. Q4’s projection is largely driven by higher prices for grains such as corn, oats and wheat. In addition, coffee prices are seeing rising through most of the year and are projected to moderate toward the end of the year. Meanwhile, soybeans prices are likely to face some volatility, while cocoa and sugar are expected to be the worst performers among agricultural commodities.
The La Niña weather phenomenon was softer than expected this year, which means that less disruptions are expected for agricultural commodity producers. A softer La Niña will provide cooler temperatures during the Southern Hemisphere summer and reduced heat damage for coffee (Arabica), corn and soybeans. Current rains in Q1 have produced a good flowering of coffee bushes in Brazil, setting up for a good crop this year. Meanwhile, better snow cover in North America during La Niña has benefited winter wheat growing. Meanwhile, following a failed monsoon in 2014 and 2015, normal rain levels in India have refilled reservoirs and such beneficial conditions should help reduce the sugar production deficit in the coming months. Meanwhile, the EU’s scrapping of the sugar production quota in October this year will increase the supply of sugar beet in Europe and reduce the demand for sugar cane, which will also weigh on prices.
Weather, however, is not the only factor influencing the outlook for agricultural commodities prices. Politics will play an arguably even more important role this year. While in Argentina the new administration under President Mauricio Macri is improving the tax and regulation frameworks—which will benefit production and exports of soybeans—, in Brazil the government continues to struggle at a time when the economy is slowly emerging from its worst recession in decades. Meanwhile, in the U.S., a commodity-export giant, the new Trump presidency is taking a step away from free trade and is intending to renegotiate trade deals in order to favor the American economy. Substantial uncertainty persists regarding U.S. trade policy and it remains to be seen if President Trump will go ahead with his full campaign promises, which have the potential to be highly disruptive for global trade.