Commodity rebound gains momentum

Despite a lacklustre performance in Q1 of this year, it increasingly looks like commodities are at a turning point, with most sectors posting gains last month

There are a number of reasons to be optimistic about the outlook for commodities in 2015 and heading into 2016. A prolonged period of low prices will likely see a recovery as supply tightens, while demand for many commodities is unlikely to be as weak as many have feared. Policy stimulus around the globe is likely to keep demand conditions favourable for most commodities. One exception in the near term is crude oil. After a strong rally in crude oil prices over the past two months, we expect a modest pull-back. The gains have been premature given that supply of the commodity has not yet materially tightened. Current prices indicate the market has pinned high hopes of a cut in production by OPEC in its upcoming June 5th meeting. With the International Energy Agency claiming that OPEC’s fight for market share has only just begun, we believe that the market could face disappointment at this pivotal meeting.

• El Niño probability raised. The Australian and US meteorological organisations have increased the probability of El Niño lasting into the northern hemisphere summer and autumn. The weather event is now likely to last into the reproductive growth phase of several crops and should its intensity increase, it could damage certain crops such as Australian wheat, cocoa and sugar.
• Gold shows it mettle. Gold tends to be the first port of call for investors anxious about an otherwise benign world unravelling. Concern about Greek finances and lacklustre growth prolonging monetary stimulus has seen demand for its defensive characteristics rise.
• Industrial metal inventories in decline. With investors appearing to be underestimating demand, we expect further recovery in prices, as supply optimism begins to fade in the latter stages of 2015.
• Energy sector to face near term headwinds. The rally in both oil and natural gas prices could run out of steam in coming weeks, as the market reassesses the abundant supply situation affecting both markets. While we expect demand to strengthen over the northern hemisphere summer, elevated inventory levels could cap near-term gains.

Sector Overview

Agriculture

• Cocoa gained 7.2% last month as falling yields in Ghana threaten to drive the market into a supply deficit this year. With meteorological organisations from the US to Australia forecasting that the El Niño weather pattern will last until the northern hemisphere autumn, we expect crop conditions to worsen in West Africa as a lack of rain will exacerbate dryness.
• The world’s top cocoa producer, the Ivory Coast has seen a relatively stable political environment in recent years, but an election this year has the kept the market on edge with memories of the civil war denting sentiment. Any disruption to exports from the Ivory Coast could significantly tighten global supplies.
• While wheat fell 4.2% in the month, reduced planting in the US and potential El Niño-related crop damage in Australia and India could drive substantial price gains. Excess rain in the US over the past week has already reversed most of the past month’s price decline.

Industrial Metals

• Industrial metal markets have performed solidly, as investors anticipate tighter market conditions in 2015 than in recent years, as Chinese demand continues to be robust. Rising oil prices and a weaker US Dollar have added to industrial metal buoyancy. Nickel led the complex higher after the International Nickel Study Group (INSG) believes demand to rise by nearly 4% this year, more than double the growth rate expected for supply.
• Copper has been the second best performer in the complex over the past month, buoyed by signs of rising demand. Chinese imports in April were 45% higher than a year earlier, against a backdrop of falling stockpiles. For what it’s worth, the International Copper Study Group data has shown the copper market to be in a modest surplus for January 2015, but recent floods in Chile could cloud the picture. One of Codelco’s mines was restarted in late April after a three week shutdown.
• Zinc has also been a strong performer on the back of falling inventories, which are lower by over 8% over the past three months. Expectations of further stimulus from Chinese policymakers should continue to provide support, despite recent ILZSG data showing around a 4% surplus for January-March 2015.

Energy

• Rig counts continue to fall, but with prices at the highest level since December 2014, a potential correction could be imminent. Rig counts in the US fell by the least since early 2012, while overall US production remains within 1% of its all-time high. Indeed, stockpiles have only fallen for three weeks after building up for 16 consecutive weeks to a record high. Oil prices, which are well above marginal cost, could be in for a sharp correction if investors begin to unwind stretched long positioning. Meanwhile, OPEC’s latest report indicated that the cartel continues to produce at least 1.5mb/d above expected demand. Nonetheless, OPEC expects a pickup in global demand of nearly 1.3%, with the largest gains expected to occur in the second half of 2015. They believe the increase in demand is sufficient to keep up with abundant supply. Anticipation of cuts at its June meeting could disappoint and prompt a modest pull-back.
• Natural gas surged following expectations of warmer US weather boosting demand in order to fuel additional demands for power. With storage levels remaining adequate and not far from the longer-term average level, we expect the duration of this rally to be short-lived.

Precious Metals

• Concern about Greek finances and global equity market volatility renewed interest in gold last month. Although Greece managed to scrape together its €750mn payment to the IMF, the fact it had to do so by tapping into its own IMF reserves account was a cause for concern. Weaker-than-expected German Q1 GDP data, a downgrade of the UK’s growth outlook and a string of poor Chinese data point to monetary easing from the world’s major central banks continuing for the foreseeable future. Gold responded decisively, gaining 1.6%, with silver riding its coat-tail gaining 5.6%.
• Platinum and palladium continued to diverge, with the latter posting a 2.3% gain and the former falling 0.2%. Slower car sales in Europe (which tend to use more platinum) compared to the US and China (which tend to use more palladium) account for the divergence over the past year. However, European car sales are growing more briskly, posting their highest volume in six years in April and we believe that platinum prices should catch-up accordingly.

Martin Arnold – Director – Global FX & Commodity Strategist – ETF Securities (UK)
Nitesh Shah – Associate Director – Research Analyst – ETF Securities (UK)