Quantcast
Other Stories

For sustained recovery in commodity prices, the demand side should get stronger, going forward. Many commodities are trading way above their cost of production, encouraging producers to boost production.

01 Mar 2013

By Kunal Shah
During the year 2012 neither the world nor the financial markets ended. A famous astrologer had forecasted that the world may come to an end in 2012. And economists too, among many things, had said that the Euro zone may break up, China may face hard landing and the US may again slip back into recession. But neither of these things happened.

Central bankers came to the rescue just in time and managed to save the financial market from something which could have been worse than the crisis of 2008. While a crisis comes in disguise, the biggest difference between the crisis of 2007-08 and the debt crisis in the Euro zone in 2012 was that everyone knew about the debt crisis in the Euro zone but very few were aware of the sub-prime housing crisis in 2007 or the bankruptcy of Lehman brothers in advance in 2008.

Interestingly, more than actions, words were enough for the markets to heal. It started with the European Central Bank President Mario Draghi who on 26th July, 2012 said: “ECB is ready to do whatever it takes to preserve the Euro. And believe me, it will be enough.” After this, these markets started to rally. Coordinated actions by top central bankers helped postpone the crisis again. After ECB, the Federal Reserve or the Fed started its controversial bond purchase programme with the commitment to continue the same, till the job market improves significantly or inflation moves above 2.5%, followed by aggressive quantitative easing by Japan, which led to a massive rally in risky assets and liquidation in safe haven instruments.

The global economy is trying to recover from the rough patch and is showing signals of a halt in contraction, except in the Euro zone. The US economy has done exceedingly well in the last two quarters, the Chinese slowdown has moderated and we are witnessing a cyclical recovery in the Chinese economy and the Japanese economy is likely to register moderate growth in the first half of the year due to aggressive stimulus. The markets, as always, have run ahead of the actual fundamentals and we are yet to see the real economy showing signals of strong growth.

Commodities have remained in the lime light since the last 4-5 years thanks to the prevailing easy monetary policies, investment demand and stimulus packages by central bankers. But the impact of these policies and packages are moderating. The actual demand is still not picking up at the same pace as in 2009 and correspondingly the supply side of many commodities has been getting stronger and stronger.

For sustained recovery in commodity prices, the demand side should get stronger, going forward. Many commodities are trading way above their cost of production, encouraging producers to boost production. Crude oil, huge inventories in OECD, record production by Russia, rising production in US and Iraq is clearly indicating that the supply side is getting stronger and correspondingly, the demand is not picking up at the same pace.

In case of base metals, we have seen huge inventories pile-up in most base metals, record production but the demand is still not as strong as supply. Inflows in top commodity index funds have remained robust and we believe that is one of the most important factors for prices to sustain at unreasonable high levels. More than actual demand, financial demand has remained robust, giving support to the prices.

In 2009, the turnaround story of China, after a huge stimulus by their central bank, led to a massive rally in commodity prices and the focus was on investment-led growth, which eventually leads to a housing bubble in China, where we have seen a rapid rise in prices followed by a sharp fall. In spite of a sharp contraction in economic activity in 2012, China has not come up with any aggressive rate cuts or stimulus packages. This makes us believe that China is focusing on transforming its economy from an investment-led economy to a consumption-led economy, which will take time. Imports of various commodities from China still remain very low, except crude oil where we have seen some meaningful revival lately.

With the recent correction in commodity prices, it is becoming very clear that more than any fundamentals, liquidity is driving commodity prices. Recently, talks by Federal Reserve officials that the central bank might have to slow or stop buying bonds led to a massive sell off in bullions, energies and metals. It clearly indicates that the run up in commodity prices is liquidity driven and talks of withdrawing excess liquidity led to a massive correction. I am still waiting for the time, when commodities prices will be determined by its fundamentals not just by liquidity.

(Mr Kunal Shah is Head, Commodities Research at Nirmal Bang Pvt Ltd) 


YOUR RESPONSE
Click on the image to reload it
Click to reload image
COMMENTS (0)

@2013 COMMODITYONLINE ALL RIGHTS RESERVED