Commodities hope: some analysts see light at end of tunnel
Are we reading the wrong signals when it comes to the outlooks for metals? Apart from the bounce on Tuesday at the London Metal Exchange, it has been a pretty terrible time for traded metals and energy. Gold has been bashed around, Goldman Sachs is now forecasting $20/barrel oil (the world is apparently running out of storage capacity as the Saudis and other producers keep pumping the black liquid) and iron ore is still on its knees.
So, not too bright an outlook, it seems. But that may be the case only if you look at copper and iron ore, for example, which are both in oversupply. Nickel, too, with mines keeping on churning out that metal. No wonder prices fell. With the big iron ore miners expanding output while Chinese demand for imports is contracting, no wonder that the Baltic Dry Index (which measures bulk cargoes on 23 shipping routes) is at an all-time low.
But hold the phone: the past few days have seen a succession of reports suggesting that the worst might be over. Well, that has yet to be proven, and many a forecast over the years has turned out wrong.
That said, some highly regarded commentators are suggesting that we look at factors other than supply/demand for various commodities.
And it is not all about China. At the moment, the market is dominated by the fall in Chinese demand, with the Baltic Dry Index being presented as Exhibit No.1.
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One point being made is that, while we are not running out of them, it is getting harder to find metals, and more costly to mine them. As Morgan Stanley points out in a new report on the yellow metal, global gold grades have progressively declined over the past 20 years and, when gold’s price was soaring, miners threw big investment into developing low grade deposits, a move they are now possibly regretting. McKinsey & Co, in a paper called Is there hidden treasure in the mining industry?, points out that its commodity-by commodity modeling suggests that, for many commodities, declining ore quality and limited accessibility of new deposits will squeeze supply in coming years, potentially driving a commodity-price rebound as global demand continues to rise.
And here’s another point, made not by an expert but this writer: who in their right mind would get involved in a greenfield rare earth project in the present climate? Given the fact that the many long years during which most of the various current advanced projects have been under way, and the fact that these projects need to go through the development phase, would surely deter any investment in something that would mean beginning from scratch. That means those existing projects, once they get up and running, would not face any newcomers coming up behind. Perhaps a factor helping Lynas at the moment is that presently there are not too many non-China supply options.
(Incidentally, McKinsey cites two fields where it believes there is scope for companies to enter. One is fertilizer where prices move more differently from those of other mining products, driven by food consumption rather than by infrastructure investment. The other is precious metals where prices exhibit limited correlation with those of other commodities during times of economic crisis.)
Here’s another view: that China’s slowdown has now largely run its course. This is the analysis of Julian Jessop, head of commodities research at Capital Economics in London. If so, he goes on, the price of copper in particular should recover.
Or not. Some commentators are arguing that the global economy will bounce but with little impact on commodities. A columnist in The Daily Telegraph of London calls it “a harmless commodity crash” because, while it affects miners, the world is getting on with other business, and there is about to be a huge surge of money into high-end real estate in certain cities. Barclays Bank is urging its clients to dive into stocks, arguing that previous interest rate moves by the Federal Reserve have given Wall Street a boost.
It’s all too early to tell, of course. The comments above examine various arguments that are now going on, but they are well worth keeping in mind as events unfold over the next few weeks and months.
Others are not so optimistic. In his weekly client letter out today, Perth-based Peter Strachan of StockAnalysis begins: “The resource sector is in atrocious state”. But even Strachan sees the commodity cycle bottoming out over 2016 and that will be a time to begin investing in stocks again.
We’ll keep you posted.
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