2016 commodities outlook: From super cycle to super correction

Last year was once again rather disastrous for commodity prices. Average prices of the base metals traded on the LME all dropped massively, while average prices of oil, iron ore and steel also fell sharply. The general downward trend that has been in place since 2011 continued.

2016a

Indeed, as can be seen in the chart below, prices of aluminium, nickel and steel are all now trading around the same levels seen 20 years ago.

2016b

In real terms (i.e. accounting for inflation), the picture is much worse, with all three of the above-mentioned commodities now at real prices far below those seen in 1995. Likewise in real terms, copper is trading at about the same level as twenty years ago, although oil is still some $5-10/bbl above its level back then.

2016c

Such has been the consistent slide in prices over the past five years that much talk in the market now centres on the concept of prices being ‘lower for longer’.

There are certainly good reasons for this hypothesis.

The scale of investment and expansion to meet growing Chinese demand during the first decade of this century was so large that demand will simply take longer than usual this time to catch up with supply for instance.

Meanwhile, supply cuts have been rather sporadic and half-hearted so far, with producers in a number of industries waiting to see who blinks first. While there are small signs here and there of supply cutbacks, they have so far not been anywhere near enough.

Producers have been holding out, perhaps in the mistaken belief that prices would soon rebound. They have also been helped by the low cost of debt, given historically-low interest rates.

In some instances, producers have actually responded to falling prices by increasing production further so as to reduce unit costs, or to at least generate sufficient cash to pay down debt.

Each commodity has its own story for the coming year of course – the global iron ore market is due to see further expansions of supply over the coming twelve months, with a number of iron ore majors believing Chinese “peak steel” is still to come; the global oil market may see supplies increase significantly as well this year with the lifting of sanctions on Iran; and the global steel industry will continue to be heavily influenced by the decisions of China’s political masters. Is it likely that they will countenance widespread cutbacks and closures at state-owned steel mills?

In addition to the supply side, the demand side of the equation also offers support for the ‘lower for longer’ hypothesis, particularly with Chinese growth slowing and with its growth increasingly driven by consumption in place of investment.

But just as many expected prices to increase indefinitely during the super cycle, so too may the existing pessimism be overdone.

In the long term, prices will undoubtedly enjoy an upward cycle again. Continued population growth and urbanization will see to that. The UN predicts that the global population will expand by some 2.4 billion people between now and 2050, and then by a further 1.5 billion through to 2100. Meanwhile, that expanding population is increasingly expected to live in urbanized areas, driving demand for new investment in infrastructure.

But looking at matters more close to hand, the short term offers little prospect of an immediate upswing. While there is some tightening in some commodity markets, and deficits are expected to emerge in some markets over the coming 2-3 years, any impact on prices will arrive very slowly.

In addition to the aforementioned slowdown in growth from China, which is seeing consumption of some commodities fall even faster than the rate of production cuts, many markets also remain burdened by large stocks, particularly in aluminium, nickel and zinc.

There are some areas that may see more price strength than others. A raft of US trade investigations on steel products have recently been or will shortly be concluded, which could help to protect US steelmakers and see prices perform relatively well there. The recent imposition of large anti-dumping duties on corrosion-resistant carbon steels (i.e. galvanized steels) from China give some indication of the growing protectionism in the USA.

But for there to be a widespread and significant increase in commodity prices this year, we will instead be relying on external factors e.g. political risk or a change in Saudi policy pushing up oil prices, or a faster-than-expected increase in US interest rates pushing some producers with large dollar-denominated debts out of business.

In the absence of such external shocks, however, prices are likely to remain subdued. While they will not remain lower forever therefore, they are likely to remain that way for much of 2016.

Sources: BLS, EIA, MBR, Steel First, USGS

This article was also published for Steel First in January 2016

 

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