Commodity price volatility will increase this year. The main driver behind this will be increasing comments and signs from the US Federal Reserve that may suggest the timing and mechanism for the winding down of quantitative easing (QE).
China will be another significant driver of volatility, as markets continue to scrutinise data releases for signs as to where the slowdown in GDP growth might level off. Société Générale is forecasting a GDP growth of 7.6% for 2013 and 7.2% for 2014 and if the delicate recovery that we are witnessing in the US continues to take hold, we expect QE to start tapering off towards the end of this year.
How commodity prices will respond if QE draws to an end is already stimulating much debate in Asia. The academic argument suggests that yields will rise, the dollar will strengthen and commodity prices will therefore fall. We must remember that while that may often be true in isolation, and the end of QE will likely precipitate such events, this will only happen if the economy is growing.
Furthermore, our analysis of past yield increases suggests that this is also unlikely to happen, as the key drivers of pro-cyclical commodities are economic growth and supply shocks, rather than interest rates.
Commodity prices will be moderately positive for the year, with most of the upside coming from energy prices on the back of robust oil demand and supportive fundamentals. There will be some interesting relative value opportunities within the industrial metals sector, but as China’s GDP growth slows, and government policies to rebalance the economy take effect, upside will remain capped. Precious metal prices will continue lower as the need for a safe haven recedes and agricultural commodities will trend lower as substantial crop sizes replenish inventory.
Ghee Peh, head of regional base metals/ mining research
We’re commodity price bears. Most investors believe that sustained commodity price falls are a function of demand weakness. And yes, trend demand growth worldwide has abated somewhat for commodities such as copper, iron ore and coals, due primarily to a maturing of China’s long-term industrialisation and urbanisation cycle. But the main reason why most commodity prices have weakened recently is because – for the first time in almost a decade – supply has finally ‘caught up’ with demand. As a result, we are now seeing surpluses form in most mineral, metal and energy markets – and even in several of the ‘soft’ agriculture commodities.
Stability of a trade’s supply-demand functions will typically deliver stable prices. In such trade conditions a series of subsequent events occur: price volatility becomes subdued; trade anxiety eases; and the risk premia that is required to engage in these trades shrinks. Finally, speculators become deterred by the lack of volatility, and withdraw. All of these shifts undermine a commodity’s price.
Eventually, drivers of volatile trade flows and price signals will increasingly be supply- rather than demand-related. Examples of these include seasonal restocking (copper, iron ore, coals, grains); wet seasons (iron ore, coals, softs); droughts (energy, soft commodities); supply shocks (mining failures; technical innovations).
In terms of short- to medium-term outperformance, we like uranium as fundamentals are improving; metallurgical coal as supply growth is stalling; and copper due to a series of large supply shocks.
Stefan Graber, commodity analyst, private banking and wealth management
The decade of ever rising commodity prices appears to be over. Improving investor confidence has helped channel abundant liquidity into equities, while commodities – more closely linked to real economic activity – have failed to benefit.
Economic growth is becoming less commodity-intensive too. More comfortable supply buffers following years of excessive capacity investment can also be blamed. In response, correlations between commodities and other assets including equities and bonds have started to drop. Price developments within commodities have also become more independent. Commodity-specific fundamentals matter again.
Therefore we call for more divergence in commodity prices. An extended phase of increased volatility is also likely. Recent price patterns have already pointed in this direction, considering the sharp fall in gold and the simultaneous rise in palladium prices. Energy market dynamics provide another hint.
In this environment selectivity will be key and active strategies should be preferred, as we believe that passive benchmarks are likely to underperform. Relative value themes have also been developing. We think that gold does not have much near-term recovery potential amid falling inflation expectations. Meanwhile, the more cyclical platinum and palladium markets are set to extend their relative outperformance given sizeable supply deficits. And crude oil prices have the potential for a moderate rebound as we approach the seasonally stronger third quarter.
Han Pin Hsi, global head of commodities research
We should continue to see divergence in price performance among commodities this year, along with periods of higher volatility that is driven by an improving global economy occasionally peppered with disappointments in macroeconomic data, particularly from China.
Commodity markets are recovering from two large downward moves since late March. The uptrend appears to be gaining support, with the DJ-UBS Commodity Return Index registering higher lows since the week of April 22.
While China remains a worry given the potential for further disappointments in the second quarter macro data, we believe this has generally been priced in and many commodities have since recovered from oversold positions. We had previously expected a moderate dip in commodity prices in the second quarter versus the first, and the magnitude of the correction surprised us.
However, our expectation of the general trend remains unchanged – commodities are likely to see a stronger second half on the back of (1) relatively oversold positions, (2) improving global economic data, and (3) improving appetite from key commodity consumers.
We believe a steady stream of stronger demand indicators will be needed to sustain higher prices; in addition, the US dollar index is now close to a two-year high, limiting the scope of the rebound. This dollar strength is expected to continue in second quarter but should ease in the second quarter, benefiting commodity prices in general.
We maintain our view of a modest rebound in commodity prices from the lows in the second quarter, followed by a more upbeat third quarter amid an improving macro environment. Fundamentally tighter commodities, including those in the energy and grain/oilseed sectors, should outperform and we expect increased volatility as prices strengthen.
Mark Pervan, global head of commodity strategy
Commodity markets are likely to remain under pressure, with few near term catalysts to change the negative sentiment currently pervading commodity markets.
The peak in our proprietary lead indicator, the ANZ Inventory Pulse Index, was in March, and points to subdued conditions at least until early in the second half of 2013. However we think the cycle will be shallow, with substantial government stimulus and liquidity injected over the past 12 months enough to prop-up commodity demand. On balance, we think prices look oversold, with funds pricing-in too much downside in the past few months.
Core to the short term uncertainty is the outlook for China, which year-to-date has surprised on the downside. This has implications for seasonal demand, which also appears to be disappointing. Strong posturing by the incoming government to curb over-capacity and house-price inflation is creating angst and one reason commodity demand from China is weaker than expected. We think this could be less of a drag in the second half as authorities move in to prop-up conditions.
For both hard and soft commodities, rising supply and/or high above ground stockpiles will be a drag for much better price gains. Base metal and coal have the biggest stockpile overhang, while rising new supply for iron ore and US oil will be a headwind for prices in the second half of the year. In agriculture markets, we expect grain and oilseed prices to ease by a further 15% over the next six months.