Commodities: Mind the better fundamentals

Commodities: Mind the better fundamentals
The past week commodities continued to trade largely on risk appetite, but also
increasingly on positive data surprises: energy and agricultural held up well whereas base
metals such as copper and aluminium lost some ground. Crude oil managed to some
extent to defy the slide in EUR/USD that has taken place as the result of the Irish debt
crisis. Gold also got some tailwind as investors look for “safety first” amid sovereign debt
fears.

The coming week will see a range of key monthly data releases out of the US including
non-farm payrolls and ISM indicators. Following the recent stream of US data, our US
economist stresses that models suggest that the decline in the ISM from here could be
smaller than previously expected and that it is likely that the eventual rebound could be
quite fast. Given the new signals we would expect the ISM to bottom around 53 within
the next 2-4 months and thereafter rebound. Such an outcome would clearly be a positive
surprise for the markets, including commodities. Also, the governing board of the ECB
convenes next Thursday.

Bubbles or fundamentally justified prices?
Following a month during which gyrations in risk sentiment and the dollar have
overshadowed movements in commodities, we have reviewed recent developments in
underlying fundamentals. Eventually, supply-demand factors should on balance prove
defining for price developments in the medium term, notwithstanding the fact that the
current “dollar flood” brought about by the extraordinarily loose US monetary policy has
sparked concerns over asset-price bubbles. However, we emphasise that there have in fact
been improvements in fundamentals to potentially sustain current price levels. Near-term
price setbacks are still likely though as equities could underperform and EUR/USD may
suffer further.

Oil: The November Oil Market Report from the IEA underlined that fundamentals in the
oil market have improved recently, mainly on stronger-than-expected Q3 OECD demand;
Q4 was also taken higher by forecasts of China resorting to diesel for power generation.
While supply rose both from OPEC and the rest of the world’s producing countries,
OECD industry stocks saw a considerable dive, now just off 60 days. Notably, we expect
that 2011 will see the first draw in global inventories since 2007.

Metals: After a rally early in the month where copper hit a new all-time high of
USD8,966 per tonne, industrial metals have suffered somewhat during the month of
November as worries about Chinese rate hikes have surfaced again. Moreover, China’s
imports of raw materials have displayed some weakness recently despite the fact that the
Asian region now seems to have shrugged off the mid-cycle slowdown seen over the
summer. Physical premia for the red metal have continued to edge higher. Aluminium
premia are still elevated in the US, but there are now some signs of falling premia in
Japan. In the near term, the big joker for base metals is the possible launch of a set of
physically-backed exchange-traded funds (ETFs) for notably copper and aluminium
which could add significantly to demand. In any case, we see market balances tightening,
mainly for copper – less so for aluminium.
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