Commodities: Sentiment improves due to energy and base metals while global markets rebalance
January 17, 2017
Commodities prices increased 13.2% over the same quarter of the previous year in Q4 2016, breaking a pattern of consecutive declines in the final quarters of the previous four years. Prices for raw materials saw a gradual improvement starting in the second half of 2016 on the back of a steady recovery in most markets that came on the heels of stronger global demand. The analysts we surveyed this month project global commodities prices to continue rising throughout this year, propelled mainly by surging energy and base metals prices. Conversely, the outlook for precious metals is less positive this year, while agricultural raw materials prices are expected to remain subdued.
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Energy prices rallied in the final quarter of 2016 and in the beginning of Q1 2017 mainly due to crude oil prices. Brent and WTI crude oil prices have increased solidly in the wake of OPEC’s first production cut agreement in ten years. The cuts, which started in January, will amount 1.2 million barrels per day (mbpd) with a further cut of 0.6 mbpd coming from non-OPEC producers, mainly Russia. The deal continues to be necessary to sustain prices and will do much to clear the large stock overhang at a time when the global oil market is slowly rebalancing. Prices for base metals also improved substantially in Q4 2016 as optimism about demand for metals and minerals has risen strongly. The outlook for industrial metals remains positive. It is supported by fiscal spending and an infrastructure-led boom in investment in China, and has also come on the back of investors’ view that Donald Trump’s infrastructure spending program will boost demand.
The global macroeconomic backdrop remains positive for commodities demand this year. After an expected 2.5% increase in 2016, the global economy is projected to experience a moderate improvement this year and expand 2.9%, according to the latest FocusEconomics Consensus Forecast for Major Economies. However, geopolitical factors, elections in various European countries and the new U.S. administration will all contribute to a highly-uncertain global context and thus to volatility in global financial and commodities markets. Against this backdrop, commodities prices are expected to increase 3.9% in Q4 2017 on the back of higher prices for energy, which will compensate for a drop in precious metals.
ENERGY | Prices to firm up due to OPEC’s agreement
In early 2016, energy prices fell sharply, led mainly by plummeting crude oil prices but they recovered over the course of the year and ended 2016 on a good note. Prices increased 21.5% from the same period of the previous year in Q4 2016 and are expected to continue rising solidly through 2017. Energy prices should take the year-on-year gain to 15.8% in Q4 2017, reflecting a broad-based improvement. 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 55.0 per barrel in the Q2 2017 and to approach the USD 60.0 per barrel mark in Q4 2017.
With OPEC’s production cut agreement, most analysts see the market being pushed into deficit in H1 2017, which should, in turn, accelerate the declines in inventories and push prices up. That said, the outlook for crude oil prices in particular, and for energy prices in general, rests heavily on compliance with the agreed production targets. Moreover, further downside risks could come from faster recoveries in Libyan and Nigerian oil production, which are exempt from the agreement. Another factor at play is a resurgence in U.S. shale oil production, which, once prices rise more rapidly and are sustained, could dampen the price recovery this year.
The impact the new Trump administration will have on oil markets remains unclear. On balance, prospects for the U.S. economy are positive and global growth is expected to pick up this year. However, the Trump presidency does present downside risks to many emerging economies, which are also key drivers of oil demand. Another crucial issue is Trump’s pledge to rip up the nuclear deal with Iran. It is still unclear whether Trump wants to pursue dismantling the accord, or if he wants to do so at all, as it has been incorporated into international law by the U.N. Security Council. But there is a chance that U.S. sanctions could be re-imposed, which could curb Iranian exports and add upward pressure on prices. A bill to that effect is now headed for the Senate and the president’s office. If approved, it would facilitate the swift activation of sanctions currently not in force under the nuclear agreement.
BASE METALS | Optimism and fundamentals drive outlook
Industrial metals prices continued to post solid gains toward the end of 2016. In Q4, base metals prices increased 15.4% annually and the rally in most categories was supported by stronger demand, a pull-back in investment by major mining companies and ongoing reform in China to reduce excess capacity. Industrial metals prices received an additional push in the aftermath of the U.S. election as investors foresaw Trump’s infrastructure program boosting demand.
The rally in copper came well before the U.S. election. Prices started to increase during LME Week in London beginning on 31 October—the annual meeting of the base metals markets at the end of October—and, although fundamentals were not fundamentally changed, investors’ sentiment about the outlook was not as bad as it had been. In 2016, disruptions were somewhat frequent and ongoing capacity closures at the beginning of this year in China provided further support to prices. Meanwhile, adherence to new environmental laws in the Philippines put nearly a quarter of the world’s nickel mine supply and the only major supplier to the Chinese pig iron industry at risk. This, along with strong demand from China, prompted nickel prices to surge in the final quarter of 2016. While it is unlikely that the Philippine nickel industry will completely shut down, the amount of the supply source that is at risk warrants a substantial premium, which will continue to push prices up. Iron ore prices saw a strong rebound in Q4 2016, sustained by a combination of robust steel demand from China and supply disruptions.
The outlook for most industrial metals in 2017 remains positive as the optimism seen in Q4 2016 will persist through H1 2017, reflecting the gradual tightening of the markets. But China’s transition to a consumption-led economy, together with industrial reform and environmental concerns, is likely to slow demand for raw materials and keep prices more sluggish toward the end of this year and through 2018. Following a rebound in the final quarter of 2016, base metals prices are expected to continue rising strongly during the first half of this year and to moderate toward the end of the year. Analysts expect prices to increase just 1.4% annually in Q4 2017 and 1.5% in Q4 2018.
PRECIOUS METALS | U.S. monetary tightening and strong dollar cloud the outlook
Precious metals prices experienced a rollercoaster ride in 2016, with the gold and silver markets particularly affected by the events that shocked the word last year. Nonetheless, the precious-metals complex rose 10.1% annually in Q4 2016, ending the year on positive note, following a strong rally in Q3 2016.
This year’s outlook for the metals is less optimistic and it will be mostly driven by U.S. monetary policy and its impact on the U.S. dollar’s performance. In the short term, the expected Federal Reserve tightening cycle will be the biggest impediment to higher prices in precious metals. Gold has traditionally performed well within U.S. hiking cycles as the yellow metal has always been seen as a hedge against inflation. In terms of monetary policy in other developed economies, monetary easing in Europe and Japan continues unabated. The ECB will continue with its monetary easing until the inflation target is met, despite market concerns that it should come earlier. In Japan, subdued wage growth and declining inflation expectations should keep the Bank of Japan from raising interest rates as well.
Looking at 2017, prices are expected to perform poorly despite the many challenging events that are appearing on the horizon. Precious metals prices are expected to receive support from physical demand, given the sharp drop last year. In India—the world’s biggest gold buyer—it remains to be seen what impact on physical gold demand the government’s recent move to curb the black market money will have. India recently withdrew INR 500 and INR 1,000 notes from circulation and cash is used extensively to purchase gold. As cash supply dwindles, consumer purchases could dry up. As a result, precious metal prices are expected to drop just 0.4% year-on-year in Q4 2017 on anticipation of the Fed’s monetary tightening and its effects on U.S. credit markets and the dollar. Analysts also remain alert to Trump’s economic policies and risks around decisions made by G3 central banks. For Q4 2018, precious metals are expected to rise to 5.0%.
AGRICULTURAL | 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.
Written by: Ricardo Aceves, Senior Economist