Commodities: Commodities - A bumpy road to recovery
April 12, 2017
Most commodity prices have moved higher in Q1 2017, but have not made a full recovery quite yet. The underlying fundamentals of the commodity markets remained positive in Q1 and are expected to continue to support the recovery throughout this year. In addition, investors maintained positive sentiment and risk appetite, as they continued to capitalize on several global dynamics including inflation, infrastructure spending, a cold start to the winter, geopolitical threats and OPEC cuts. These factors contributed to commodity prices averaging 23.5% higher year-on-year in Q1, following a 13.2% increase in Q4. However, several key commodity prices have suffered a blow at different points in the early days of Q2, raising question marks. The analysts we surveyed this month remain confident that fundamentals will be the key driver behind the performance of commodity prices, although a higher degree of volatility is now being factored in. Commodity prices are projected to increase 4.8% year-on-year in Q4, up from the 3.8% increase expected last month. Q4’s expected increase will mainly be pushed by higher energy, base metal and agricultural prices. Conversely, prices for precious metals, led mainly by gold, are projected to fall in year-on-year terms in Q4 2017.
The rebalancing of the oil market remains on track as a result of the deal between OPEC and non-OPEC producers to curb oil output in the first half of 2017. The gains in crude oil prices seen in the final quarter of 2016 were extended into the first quarter of this year, although with less impetus given the slow inventory draws. Prices for base metals increased strongly in Q1, reflecting an ongoing improvement in global economic activity, as suggested by a rise in PMIs across the globe. China’s strong demand for base metals contributed to this increase too. Agricultural commodities also saw an increase in prices, pushed mainly by higher oats, soybeans and coffee prices, as well as other soft commodities such as cotton, sugar and wool. This compensated for drops in the main grains, corn and wheat, and a further sharp decline in the price of cocoa. Prices for precious metals were higher in Q1, thanks to higher investor demand for safe haven assets, as well as due to a notable increase in palladium prices.
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Base Metals: Fundamentals to drive up prices
With demand expected to remain strong this year and supply suffering from unplanned disruptions, the outlook for base metal prices is positive. Panelists remain optimistic about the outlook for base metal prices, which increased substantially in Q1, reflecting in part a base effect from the ultra-low prices registered in Q1 2016. For the next quarters, the rally is expected to continue, but to cool off toward the end of the year as the market is likely to be near balance. As such, commodities experts forecast base metal prices to increase 3.9% year-on-year in Q4 2017, mainly reflecting higher prices for aluminium, copper, lead, nickel and zinc, which will offset declines in the prices of alumina, iron ore and tin. Regarding steel, U.S. prices are projected to rise strongly in the fourth quarter, reflecting positive sentiment, while prices in the European market are expected to drop.
Supply side issues continued to batter the base metal markets in Q1, with copper facing significant disruptions at the world’s two largest copper mines in Chile and Indonesia. Therefore, copper prices were substantially higher in Q1 and sentiment for prices is positive in the coming months, given the expectation that issues at Escondida may spread to other Chilean mines as workers’ contracts will come up for renewal. Chile accounts for nearly 15% of the world’s copper supply. Meanwhile, in Indonesia, the Grasberg copper mine remains in limbo as Freeport continues to negotiate with the Indonesian government about the new mining and export licenses. In addition, the Philippines is forging ahead with closures of nearly half of its nickel industry in response to environmental regulations. The Philippines is the world’s largest nickel producer, accounting for about 20% of the world’s nickel mine supply in 2016. Overall, the impact of unplanned supply disruptions on these markets is expected to be considerable. Aluminium prices performed well in Q1, thanks to a clampdown on Chinese production due to environmental concerns. Earlier this year, the Chinese Ministry of Environmental Protection and the National Development and Reform Commission ordered producers across 28 northern cities to reduce output by more than 30% during the winter months. This represents nearly 18% of the world’s aluminium capacity.
Positive prospects for the base metal complex are the result of demand remaining relatively strong and the continuation of temporary supply disruptions. The markets are gradually rebalancing, 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.
Agricultural commodities: Prices to perform erratically this year
Agricultural commodity prices are expected to perform erratically this year, reflecting growing volatility in these markets. The outlook for the end of the year is positive, albeit characterized by considerable differences among raw materials. Prices are projected to increase 5.3% year-on-year in Q4 2017. Q4’s price rise in this complex will be largely driven by higher prices for grains such as corn, oats and wheat. Moreover, coffee prices are projected to rise through all four quarters of the year, but the increase is expected to slow toward the end of the year. Meanwhile, soybean prices are seen facing volatility this year, while cocoa and sugar are expected to be the worst performers.
Fundamentals for key grains such as corn, oat and wheat are expected to remain in place, with stronger global economic activity and demand from China driving up prices for these commodities. In contrast, soybeans are projected to underperform their grain peers given a stronger-than-expected summer crop this year, particularly in Brazil, despite the road blockades in Brazil at the outset of the year and the strike at the Rosario port in Argentina. Soft commodities, such as cocoa and sugar, are expected to be the worst performers among agricultural raw materials. Weakness in cocoa prices persisted in Q1 and analysts project they will continue falling throughout this year, owing to expectations of a return to strong global cocoa production this harvest year. According to the International Cocoa Organization, a structural surplus is likely to last for some time. Meanwhile, sugar increased strongly in Q1, but prices are projected to fall in Q4 as a result of falling ethanol prices in Brazil, higher expected production and exports in Indonesia, and plans to restrict imports in India this year.
On the weather front, the La Niña weather phenomenon was softer than expected this year, which means less expected disruptions for agricultural commodity producers. However, politics is likely to have bigger influence than the weather on the performance of agricultural commodity prices this year. As mentioned in our previous report, while the Argentinian government is improving tax and regulation frameworks, which will have a positive impact on soybean producers and exporters, in Brazil the government continues to struggle to pass legislation at a time when the economy is slowly emerging from a deep and protracted recession. Meanwhile, in the northern hemisphere, the new U.S. administration under Donald Trump remains keen on renegotiating trade deals to favor the economy. High uncertainty persists on this front, but if President Trump goes ahead with his campaign promises, this will have the potential to disrupt global trade flows.
Energy: OPEC cuts lift prices, but inventories remain high
The outlook for energy prices is positive. Forecasters project energy prices to increase 11.8% year-on-year in Q4 2017, reflecting higher prices for crude oil and its distillates—gasoline and gasoil. Henry Hub natural gas is also expected to have a brighter year, compared to 2016. Moreover, coal prices—both thermal and coking coal—will extend last year’s gains through this year, but are seen losing impetus in the final quarter. Meanwhile, forecasts for uranium suggest that its price will perform erratically this year.
The rebalancing of the crude oil market remains on track, with production constraints and robust demand likely to accelerate in the coming months. OPEC cuts remain ahead of schedule and demand has been better than expected in Q1. The only negative surprise has been U.S. drilling activity in response to higher prices, which has started to feed into higher output. Consequently, concerns persist that crude oil inventories in the U.S. will remain excessively high, raising questions about whether OPEC cuts will be enough for a quick rebalancing of the oil market. Thus far, OPEC and non-OPEC producers have been cutting output aggressively in an effort to reduce the overhang of global inventories that have built up over the past two years. In many instances, producers have cut more than required, meaning their combined progress is well on track. However, the market is becoming increasingly impatient with the rebalancing, adding further pressure on OPEC to extend the cuts to the second half of the year. The cartel’s next meeting is in May and the market is expecting OPEC members to announce the extension of the cuts at that stage. In general, there is still upbeat sentiment that, even if U.S. shale production rises, OPEC’s output reduction will bring inventories back down to sustainable long-term levels. As such, crude oil prices are projected to range between USD 55–60 per barrel in the final quarter of 2017.
Precious metals: Safe haven demand provides support
Precious metal prices will continue to find support from investor demand for safe haven assets, but market expectations of a more hawkish U.S. Federal Reserve and a strong dollar pose headwinds to this metals complex. Precious metal prices are forecast to fall just 0.8% year-on-year in Q4 2017, chiefly due to lower gold prices. In contrast, prices for palladium and platinum are projected to rise substantially, reflecting mainly stronger demand for these metals for their industrial use.
Precious metal prices have continued to find support from stronger safe haven demand for gold and silver and higher industrial demand for palladium and platinum. Gold rose in Q1, reflecting investors’ concerns about political uncertainty and near-term weakness in the U.S. dollar. However, weakness in the physical market and another increase in the U.S. interest rate curbed optimism for the yellow metal. Political and geopolitical uncertainty intensified in early 2017, with Brexit and President Trump’s combative trade policies resulting in a fall in risk appetite. Beyond the paper market, the physical market was, as expected, weak in India, following Nerendra Modi’s demonetization policy. The removal of INR 500 and INR 1,000 notes in November 2016 has encouraged consumers to retain cash for essential purchases and hold back on purchasing gold, prompting gold imports to plunge. However, more recent data signals that imports rose in recent months, providing some relief to the physical markets. Nonetheless, for the market to recover there will need to be a clearer pickup in consumer demand to suggest that physical demand has returned to normal.
While it is difficult to forecast political and geopolitical developments, the risks in the current climate provide the necessary uncertainty to attract investor demand for safe haven assets and support prices to an extent. However, market expectations for further increases in U.S. interest rates and weakness in the physical markets for gold and silver will continue to add downward pressure on prices.