Recent commodity market conditions

Recent commodity markets dented by headwinds including currency fluctuations, China’s economy, and cost deflation have resulted in weak investor returns. Commodity prices have been tied up between excess production capacities, U.S. dollar appreciation and weaker emerging market economic growth. In a way, Deflation (excess production capacity and rising productivity), Divergence (stronger US dollar and weaker Emerging Market currencies) and Deleveraging (significant EM credit and macro imbalances), the 3D’s of macro have been in the spotlight in the recent times (Goldman Sachs). Macro-economic factors have an influence on the commodity block; firstly with further policy support in China and a renewed focus by the central government on economic growth rather than reform has boosted demand expectations. Changing rates expectations in the U.S. has brought dollar weakness further increasing inflows in commodity funds. The rise in commodity prices may be a short term phenomenon as of now from oversold market recovery and/or seasonal factors. Experts expect to see restocking activity and a normal seasonal lift of China's peak materials consumption mid-year.
 

Shanghai /S&P 500 Correlations (Source: Thomson Reuters)
 

Performance

According to a report by the U.S. investment bank Citi, commodity assets under management (AuM) in February registered the sharpest monthly result since 2007. The retail and institutional passive index, ETF and hedge fund AuM linked to commodities surged 41% month-on-month and 8% on an annual basis to $337.5 billion. With regard to Oil highlights starting March 2016, the price of a barrel of Brent Crude went up to $40, nearly 50% from its January low of $28. Industry experts believe that global non-OPEC supply is seen continuing and pulling back throughout the year. The recent commodity crash has revealed a new growth sector in the coming years and the market seems to be discounting this growth. Not all commodities crashed in the last few months. The long term commodity charts, except oil, the industrial metals copper, aluminum, lead are well above the 2009 levels. Gold had a strong start to the year with the precious metal up about 20%. The best performing commodities year-to-date under metal category include manganese, alumina & zinc. The rise in the industrial metals has thus triggered an upsurge for some mining stocks recently.
 

Iron Ore Price (Source: Thomson Reuters)
 
Iron ore performance: According to industry analysts, rise in steel prices has been speculative and there has been no real improvement in demand as there are no changes in fundamentals. The market is still concerned about the global industry which has overcapacity especially China which will be a long term dynamic and will be drag-down for steel and iron ore market. However, in the short term, this potential restructure may prove to be a positive one and will remove some of that excess steel in the market thereby pushing the steel prices higher supporting the raw material market. Globally, iron ore prices recorded year-to-date gains led by a steel supply deficit and better margins required to increase production ahead of the Chinese peak demand season starting in the second (April - June) quarter.

Impact on companies

With the slump in commodity prices and the valuations of many natural resource firms continuing, companies have had to realign their business processes in order to remain competitive. This strategy is expected to continue in the face of the ever more stringent regulatory, reporting and capital requirements being asked of the industry given the current scenario.
 

Commodities Balance (Source: Thomson Reuters)
 

Outlook and investing options

As per the World Bank report (released in last week of January 2016), crude oil prices for 2016 are forecasted at $37 per barrel compared to its $51 per barrel projection of October 2015. It is reported that the anticipated oil price recovery is forecast to be smaller than the rebounds that followed sharp drops in 2008, 1998, and 1986. The price outlook remains subject to considerable downside risks. Meanwhile, all main commodity price indices are expected to take the heat in 2016 due to persistently large supplies, and in the case of industrial commodities, slowing demand in emerging market economies. In all, prices for most of the commodities the World Bank monitors were revised lower for the year. Non-energy prices are expected to slip 3.7% in 2016, with metals dropping 10% after a 21% fall in 2015. The World Bank has lowered its forecast for 2016 iron ore prices to $42 a metric ton from the earlier forecast price of $59.50 made in October 2015. This may go up to $51 per metric ton for the period till 2020.

All said and done, a rebound in global economic growth and demand is believed to bring stability in commodity prices which is expected to happen over some time. Further a boost to dollar denominated commodities is seen to be coming from factors such as the recent drop in the US dollar index at the back of the unchanged benchmark interest rate by the United States’ central bank with cutting the forecasts for rate hikes by 50 basis points in 2016 and 50 basis points in 2017. This has led to a rally with oil moving above $40 per barrel.

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