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Batten down the hatches on industrial commodities

Batten down the hatches on industrial commodities

Investors in industrial commodities may need to batten down the hatches in the year ahead, while precious metals could show improved signs of growth over the next three years, says the Head of International Mining & Metals at Standard Bank, Rajat Kohli.

“It is going to be challenging for industrial commodities, as it is not an easy environment. Patience will be needed,” he says.

While copper recently recovered from five-and-a-half year lows after a vicious sell-off, prices remain well below US$6,000 a tonne and still remain under pressure.

Although there is sustained evidence supply is coming under control as companies cut production levels to manage supply better, Kohli does not foresee a short-term recovery. “It depends on how deep we are into the price curve relative to what producers are producing. There will be more pain,” says Kohli, who is based in London.

While precious metals are in for a “pretty challenging year,” Standard Bank prefers them over base and bulk metals.  “I sense there will be greater relative price strength over the next three years,” says Kohli.

According to the World Bank’s latest commodity research, the precious metals price index declined 8.4% in the fourth quarter of 2014 and fell to a four-year low in November, with platinum, gold and silver down 7, 10, and 20% for the year, respectively.

After finding some price support in the first half of 2014 due to receding geopolitical risks, fundamental weakness of the markets contributed to the declines in the second half of the year as physical demand for precious metals by traditional buyers, notably China and India, is off compared to the previous year, when a large drop in prices induced buying, says the World Bank.

Factors that could prove critical to prices and prospects for mining companies will be Chinese demand, oil prices, the impact of currency price movements, US interest rates, and quantitative easing in Europe.

While costs for some miners and producers will decline due to lower oil and gas prices, this does not necessarily translate into improved bottom lines. “It also puts downward pressure on commodity prices,” says Kohli.

Oil prices went into freefall from June last year to lose 55% in value amid a plunge to their lowest levels in five years. According to the World Bank, this was the third-largest seven-month decline of the past three decades for oil, only the 67% drop from November 1985 to March 1986 and the 75% drop from July to December 2008 were larger.

But just as important as the future of oil prices, is the outlook for China’s economy. According to the World Bank, strong and sustained economic growth in emerging economies, notably China, has been the most frequently discussed driver of commodity prices, not only as a cyclical factor but also as a key cause of the post-2000 super cycle. This cycle is a primarily demand-driven price cycle that lasts several decades instead of the few years typically associated with the cyclicality of economic activity.

By 2012, China consumed almost half of the 91 million tons of metals produced globally, up from only 4% of global supplies of 43 million tons in 1990. In contrast, OECD economies consumed as much metals in 2012 as they did in 1990.

Kohli says any slowdown in China and global growth levels is negative for the commodity sector. “We have seen a significant correction in prices and it is a concern if there is a further slowdown in growth,” he says.

Kohli points to concerning new statistics around growth for both China and the world economy.

China’s GDP growth print was 7.3% during the last quarter of 2014, while growth momentum slowed in the quarter. The IMF, meanwhile, cut its global growth forecast to 3.5% for 2015. It also cut South Africa’s growth forecast to 2.1%. “Nonetheless, it should be noted that slower growth is off a larger GDP platform.”

Kohli says a strong dollar translates into weaker local currencies. This provides relief for producers whose inputs are largely priced in their home currency, but also places pressure on commodity prices because they are priced in dollars.

Looking ahead, aside from price volatility arising from geopolitical events, there is a focus on US interest rate strategy and the success (or otherwise) of the European Central Bank’s quantitative easing programme for the Eurozone.  “These events, together with the impact on currencies, need to be balanced against each other,” he says.

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