Year 2014 was worst for most of commodities and prices had fallen sharply. Gold, silver and crude oil prices have fallen by 14%, 27% and 50% from their year 2014 highs level. The reason is the global economic slowdown which has diminished demand for energy, minerals, and agricultural products and most of the major economies Japan, Eurozone etc. are under threat of deflation. Large commodities consumer country China likely to grow at slower pace.
In our opinion US monetary policy has significant importance in determinant of commodity prices in 2015. The Federal Reserve have ended quantitative easing in October and there is wide anticipation that FED likely to raise short-term interest rates later sometime in the current year. In past 1980 US real interest rates sharply increased and dollar commodity prices tumbled, in the 1970, 2002, and 2007 period real interest rates fell followed by rising commodity prices.
Rise in interest rates in US triggers shifting out of commodity contracts (hold by portfolio managers) and into treasury bills .High interest rates reduce the price of storable commodities by increasing the incentive for extraction in present instead of future so boosting the pace at which oil is pumped, gold is mined etc. High rates also decrease firm’s desire to carry inventories.
Let us see main commodities analysis on bye one.
(Chart 1:Crude Oil)
Plunging crude oil prices was significant event for year 2014.Brent crude has fallen by 49% in last 1 year. It is attributed to supply glut and lower demand due to global economic slowdown also Organization of Petroleum Exporting Countries (OPEC) pledges to keep supply constant despite plunging oil prices in November 2014.
The top five oil producing countries are: Saudi Arabia, Russia, United States, Iran, and China. The top five oil consuming countries are: United States, China, Japan, Russia, and Germany. Clearly all top five oil consuming countries are struggling for growth and reflects crude oil prices.
US Oil production
(Chart 2:US crude oil production)
U.S. oil production has grown rapidly in recent years with the U.S. Energy Information Administration (EIA) data reflecting combined production rise from 5.7 million barrels per day (bbl/d) in 2011 to 7.4 million bbl/d in 2013. Chart shows US oil production and import trends. US Oil production is expected to increase in the near future at a rapid pace with the Shale Oil revolution. The increase in the production of oil from the US is expected to keep the crude oil prices in check in the long term. In the longer term, real prices are expected to fall due to growing supplies of Unconventional oil, efficiency gains, and (less so) substitution away from oil.
Gold prices have fallen by 1.6% in last year. Gold is seen as a safe haven asset in times of crisis points in the global economy. The credit bubble bursting in 2007-08 provided a good crisis point for gold as it lead to many issues such as sovereign debt crisis in the Eurozone and rising inflation expectations in emerging economies as global central banks pumped in money to bring markets under control. Gold prices had more than doubled in both USD and INR terms to highs since 2008.
(Chart 3 Gold Source: world gold council)
However with markets stabilizing, gold does not have a strong footing behind it to outperform financial assets. Gold has underperformed equities over the last one year and will continue to do so unless there is a fresh crisis point emerging in markets. At this point of time that crisis point is not seen on the far horizon.
Gold is considered a hedge against inflation but expected inflation rate is falling for many major economies, we expect gold price can remain soft to stable during 2015.But FED raising interest rates later in year can attract some risk averse flows into.
Silver prices have fallen by 24.06% in last year as world has stated to enter into bear commodity cycle. Silver prices had shot up five fold in the 2009-2011 period on the back of worries over the collapse of the Euro and the Eurozone and on the back of inflation worries in emerging markets. However, stability in the Euro and limping back to normal in the Eurozone economy coupled with falling inflation levels in emerging markets have resulted in the value of Silver as a currency risk and inflation hedge falling sharply.
Silver prices are more likely to move on demand and supply going forward and sharp rise in the metal price is not on expected as global economy is seen slowed and inflation expectations are being controlled in emerging markets.
(Chart 5 aluminium)
Base metal Aluminium prices have risen by marginal 5.6% in last year.
China is the major demand driver for aluminium as nearly 40% of demand is coming from the country alone. The Chinese markets remains in surplus and capacity continues to rise. But Aluminium prices strengthened as production cuts outside of China have moved the market excluding China into deficit and other reason is substantial volume of aluminium inventories are tied up in warehouse financing arrangements and are not available to the market.
Aluminium plays a key role in any economy growth story due to its wide application in key sectors like Power, Automotive, Construction, Consumer Durables and Packaging. So we are expecting that India can be demand driver after China as economic growth accelerates at end of 2015.
Copper was the only exception in the base metals complex, with a price decline of more than 10% since 1 January. In 2014 the copper price was strongly influenced by economic developments in the main copper consuming countries and major one-off events in China, such as the bond default of Chaori Solar and the Qingdao probe.
Copper is the third largest consumed metal in the world after steel and aluminium. Copper is used as electrical conductor, construction material and as components in telecommunications and alloys. Copper outlook largely depends on the demand from emerging economies in Asia and specially China. Asia on the whole account for 55% of total global demand whereas China alone account for 40% of demand. China GDP growth at levels of 7.5% in the 2012-2014 period is below double digit growth levels seen in the 2000-2010 decade. The trend growth slowdown is impacting demand for Copper as China is struggling with over investments. Copper prices are likely to stay at lower levels given that China’s demand is not likely to surge.Copper production projects in the major copper producing countries like Chile, Zambia, the Democratic Republic of Congo, Peru and China are at the different stages of development. Considering that it will take 3-4 year for these project to go on stream, they will not affect the copper price during the next two years. Chinese demand is not the only major factor to consider in the outlook for copper. The world is also beginning to feel the impact of supply challenges. When it comes down to the production of copper, the industry is experiencing difficulties from various aspects of the production cycle.
Steel billets prices have crashed from USD 600/tonne to USD 200/tonne in the 2011-2013 period but have recovered more than 100% from lows. Steel billet price is at USD 485/tonne on LME (London Metal Exchange) as of this month. However global capacity is higher than demand and until rationalization takes place globally and demand supply will determine direction of steel prices in future.
From January until September, global crude steel production was up by 3.4%, despite the overcapacity. We expect demand can be driven by the positive economic data, the outlook on car sales and construction sector. As the US economy registering growth, steel demand activity is expected to remain solid there. In China the steel demand is expected to remain sluggish, with rising inventories, relative low manufacturing indicators and muted real estate sector.
The Thompson Reuters/Jefferies CRB Index (CRB Index) is a commodity index that tracks a basket of 19 commodities that are traded on the NYMEX, CBOT, LME, CME and COMEX Exchanges.
(Chart 8 :CRB index)
The Thompson Reuters/Jefferies CRB Index (CRB Index) have declined by 17.39% in last year. The fact that this commodity index that has weights of 23% in crude oil and 12% in industrial metals such as Aluminium and Copper is down 50% over the last six years suggest that demand supply metrics of commodities has tilted in favour of the latter.
Depressed commodity prices are both positive and negative. On the positive side inflation expectations are down leading to interest rates coming off. On the negative side, global growth imbalances will increase with technologically advanced countries such as US, Japan and Germany growing faster than countries such as Russia, Brazil, Middle East and other commodity export driven economies. The US dollar will benefit from lower commodity prices as growth imbalances heighten.
Nickel and Zinc
(Chart 10: Zinc)
Non – ferrous metals Nickel and Zinc prices have risen by 5.66% and 6.28% in last one year respectively.
Nickel and zinc prices increased primarily on future supply concerns. For nickel, the Indonesian export ban on unprocessed materials was the main trigger, while in zinc the planned closure of mines fuelled speculation.
Agricultural commodities have shown a mixed trends in year 2014.But coffee Arabica prices have surged by 58.6% in last year because weather problems and drought in largest supplier of coffee Brazil. The global coffee market is likely to experience deficit of almost 2 million bags. The market expects multi-year record production levels for most of the grains. Good crop prospects for most agricultural commodities prices in the check for 2015.
Chart 12: Coffee Arabic)
India in sweet spot
India will benefit from lower oil prices as oil forms around 38% of its subsidy bill. Inflation expectations come off as lower oil prices lead to lower deficits, lower inflation and lower interest rates. Indian equities, bonds and the currency will benefit from depressed commodity prices.