Sunday, October 31, 2010

Commodities: Super-cycle resumed?

The past week has generally seen commodities trading higher although it is worth noting that support from EUR/USD has waned. Key to the direction for commodities from here is next week’s Fed meeting as the markets expect to get clarification as to the extent and timing of more quantitative easing.

We have just published new commodity-price forecasts, see Commodities Monthly; some highlights are given below. Overall, we remain bullish on commodities in 2011 on tighter market balances and a weaker dollar.

New price forecasts: market balances tightening
While the business cycle has been supportive for most commodities since mid-2009 when the global economy started to recover from the recession, the IMF in its latest World Economic Outlook (WEO), published early-October, revived the idea of a “commodities super-cycle” – not least for industrial metals. The fact that growth going forward is projected to come primarily from emerging markets where activity is markedly more
commodity-intensive than elsewhere coupled with concerns that supply may not be able to keep up – as output usually adjusts only very slowly – is potentially creating a “perfect storm” – i.e. a combination of supply and demand driving prices higher still.

While long-term scarcity is one likely driver of supply constraints for the mineral industry, the IMF highlights that the main factors include long implementation lags for discovery, exploration and investment in the metals sector. In addition, the existence of technological and geological limitations is crucial for metals such as copper and tin whereas environmental policies may hinder expansion of production capacity within the lead and aluminium industries. IMF estimates that prices of base metals are only halfway through the current super-cycle, which was likely initiated just prior to the start of the new millennium and thus concludes that the balance of risks for metals prices in particular may lie persistently on the upside for years to come.

The notion that the Great Recession constituted little more than a temporary halt to a commodities super-cycle also received a lot of attention during the annual gathering of the base-metals community for LME week in early-October. However, we are not uncritical of subscribers to the super-cycle theory. Global demand could still take a hit – for example as extraordinary policy stimuli are eventually removed – and/or suffer from
an extended period of below-trend growth. Also, the supply response may be quicker this time round compared with history, due to technological advances.

Notwithstanding, we remain bullish on the commodity complex as a whole going into 2011, partly on supply-demand fundamentals and partly due to the fact that our FX strategists now look for dollar weakness on a one- to 12-month horizon; see FX Forecast Update. We have thus pencilled in slightly higher oil prices and see Brent trading at USD82/barrel (previously USD80/barrel) on average in Q4 and close to USD88/barrel
(previously USD86/barrel) in 2011. Setbacks on fading leading indicators should still be expected in Q4. As commodities will likely continue to shadow dollar movements to a large degree, key events to look out for in the near future include the Fed meeting on 3 November and G20 meeting on 11-12 November, as both should shed more light on where the dollar is heading from here.

Full report: Commodities: Super-cycle resumed?

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