As the year 2010 came to an end, it is interesting to look back and wonder how commodity markets (energy, the entire metals complex and agriculture)
in 2010 were driven by a combination of factors including macroeconomic data, sovereign debt issues, differential monetary policies, demand strength, weather aberrations and currency dynamics. Cautious outlook at the beginning of the year has now gradually given way to robust optimism. An indication of growing confidence about growth prospects is that commodities production, consumption, trade and prices all hit new highs during the year.
Looking back, it is evident, the prices of copper and gold hit historical levels in 2010. Silver and sugar prices reached their 30-year highs. Demand strength has made a significant contribution to the price spurt in energy (crude and coal) as well as metals. Commodity prices have surged to record nominal highs in recent days and oil continues to consolidate near the $90 a barrel mark. It is important to realize that while most commodities are at record nominal highs, they remain well below their inflation-adjusted highs seen over 30 years ago during the stagflation of the 1970s.
Gold price rallied more than +28% in 2010, marking the strongest rise since 1979 when price more than doubled. There are two main reasons driving the metal higher: sovereign crisis in the European periphery and QE by the Fed. These two factors will continue to support gold next year. In 2Q10, gold made a record high of $1,266 as Greece was facing insolvency and the euro was threatened to be disintegrated. At that time, gold was trading in sync with US dollar, signaling extreme risk aversion. In early November and early December, gold also surged to all-time highs of $1,424 and $1,432 respectively amid resurface of sovereign concerns in the 16-nation region. Ireland was at risk and sought bailout from the EU/IMF in late November. However, it failed to stem contagious risks and the problem continued to spread to neighboring countries such as Spain and Portugal. The problem remains unresolved so far. While the post-2013 mechanism may be helpful in the future, EU finance leaders failed to agree on new initiatives to solve the current crisis.
Silver has been one of the best-performing commodities in 2010, with prices rising by 83% compared to gold’s 28%. As a result, the gold:silver price ratio has fallen steadily this year, hitting a four-year low of 45. Silver rose above $30/oz for the first time in 30 years, as concerns over falling currencies increased investment demand for safe haven assets. The record was set on 30 December in London as the euro and the dollar slumped amid nervousness over the European debt crisis, and comments from Ben Bernanke, Federal Reserve chairman, that the US central bank could increase the size of its quantitative easing program.
Base metals are going from strength to strength with benign macro picture and robust demand. Improving demand, the ongoing economic recovery and tightening market balances are all price positive. In addition to emerging market demand, recovery in OECD demand (especially Europe) has been a big surprise. The launch of the first physically-backed base metals exchange traded funds is another contributory factor. The copper market in particular is already in deficit. In addition to recent labor action in a Chile mine, closure of an important port is seen exacerbating the already fragile supply situation.
Crude oil prices hit a two-year high in last week of December. The year saw unexpected demand expansion and commensurate inventory drawdowns. At the beginning of 2010, hardly anyone could have imagined such a huge demand surge. Crude oil underperformed the commodities space in the most recent rally, despite the fact that the benchmark US crude oil price averaged around $81 a barrel in 2010, up from last year's average of $61 per barrel; 15% higher than the beginning-of-year consensus of $71 per barrel; and around 5% higher compared to the previous Energy Information Administration's outlook for $78.67 per barrel
Volumes in Agri Commodities in 2010
Most of the agricultural commodities that performed well, were not the common man’s commodities, which can propel the bourse claim that futures trade has nothing to do with price rise. More so it is the economics of demand and supply that decides the market dynamics, a common knowledge that now has very few takers.
Guar seed has been the winner all the way in 2010. Its volume stood a clear first with 108,075,810 MT while its value in trading was 251,429.97 crores. Soybeans came second with a volume of 46,009,580 MT and a value worth 97,705.73 crores. Value wise, soybean is fourth since the third position is taken by chana with a value of 102,135.46 crores. Chana’s volume at NCDEX stood at 44,123,720 MT, which is third ranked. Third ranked in terms of value, refined soya oil traded with a value of 183,876.36 cr in its volume of 36,291,680 MT.
However, some agri commodities fared poorly. Among them are coriander with 449 crores and maize with 936 crores. Barley and chili also returned with non-impressive figures far less than their potential.
Since MCX has taken the first mover advantage in crude palm oil, cardamom and mentha oil, NCDEX has returned negligible volumes and value for these three.
But NCDEX has witnessed volatility in those commodities irrespective of their volume or value. Take for instance turmeric, which had the highest volatility constantly breaking upper and lower circuits. It had a volume of 4,123,845 MT value pegging at Rs. 47,674.73 crores which is a distant ninth in terms of both value and volume.
Heading into 2011
Heading into 2011, there are three major themes that will dominate price action and traders will need to account for them when deciding which positions to take. The first is the European debt crisis which is currently at the forefront of trader’s minds and has everyone looking to bail on the Euro as speculation grows that the single currency’s days are numbered. The second theme is will the US labor market find traction and propel growth in the world’s largest economy, negating the need for additional QE from the FOMC. The third is how long will emerging markets and in particular China continue to drive the global economy and will their governments step up their attempts to slow domestic growth as inflation risks grow.
The recovery in the 16-member euro zone is fragile and growth will come under pressure in the medium term as governments plan to implement tough austerity measures. Looking ahead, if appropriate action is not taken, the negative spillover effects of the recent developments will likely be an unemployment rate nearing 15%, a mild recession, and renewed housing concerns. As the bloc faces major headwinds in achieving a self-sustaining recovery, the European Central Bank is expected to remain on the sidelines for most of next year, with realistic thoughts of raising rates returning in the fourth quarter. Moreover interest rate expectations in the US may push higher next year due to the Fed’s second round of quantitative easing. All in all, market participants may witness the euro come under increased selling pressure in 2011 against the US dollar.
At the moment, Commodities can be best described as “drifting higher” as prices respond to an extremely favorable backdrop of low interest rates and accelerating economic growth.
The opportunity for corrections in 2011 will take place when this bullish paradigm is upset in some way. Already we have seen interest rates on the long end make a leg higher. If they make another such move, say the 10-year Treasury at 4-5%, we may see some impact on equities and crude. Then there is the prospect of potentially many more rate hikes from China. If growth in the world’s second largest economy slows more than expected, that will have a tremendous impact on crude. Until then, however, the trend is decisively higher.
Despite gold's 28% increase in 2010, it remains 35% below its inflation adjusted high of January 1980 which was $2,300/oz. The US dollar cannot be singled out as the root cause of the latest gold rally either, since it is no weaker than a month ago and the gold:dollar correlation is moving ever closer to positive territory. Nor is it necessarily concerns over eurozone debt levels, although the gold:dollar correlation does imply an element of risk aversion. Although we have concerns that the current rally appears to be a momentum driven bubble, it may well continue through 2011. As long as the US Federal Reserve is engaged in efforts to stimulate the US economy with rock bottom interest rates and quantitative easing programs, gold will find favor among investors. Eurozone debt default is another cause of concern for wary investors, while Chinese investment demand is also growing strongly but quietly in the background. Gold will rise probably in 2011, too, to break new records and target $1,600 at Comex. We are still far away from euphoria. Although gold has attracted some first time investors prompted by fear and searching for a safe haven for their capital, gold is far away from being a crowded trade.
Silver is benefiting from a strong recovery in industrial activity, particularly in China, where industrial production from January to October grew 16% versus the same period in 2009. All this rapid growth has resulted in a 37% y-on-y increase in Chinese imports of silver in Q3 10. Silver is one of the main components used in the manufacture of the leading type of solar panels and with China’s determination to cut its energy use, the grey metal will continue benefiting. Rising industrial activity in Asia and growing debt concerns in Europe are playing into silver’s strengths. As long as these conditions persist we expect the precious/industrial metal to prosper.
Prices are forecasted to touch $40 in 2011.
Copper, which has risen to new record prices of more than $9,000/t, with even tepid investor interest in the new copper ETP will see prices reach more than $10,000/t in 2011. But the journey will be volatile if the copper-backed ETPs attract short-term bets. This is especially true during supply disruption events, which normally send copper prices higher anyway. We anticipate physically backed copper ETPs might account for as much as 150,000t-200,000t of copper by the end of 2011, which is some 57% of total LME copper stocks as of 30 December 2010 (376000t). Chinese demand, ETPs, falling LME stocks and the weak mine supply profile all suggest the copper price could be in for a bumper year in 2011. But Chinese inflation remains a worry and if Beijing is aggressive in its approach to staunch money supply, then a sharp correction could be on the cards. Developments in China will continue to be closely watched. Frequent tightening of monetary policy to contain inflation has been somewhat discouraging; yet, the underlying demand is seen as robust. Restocking demand is likely to emerge soon.
The price of crude oil stands at a historic juncture. The demand picture continues to be mixed. Despite the moderation in the Chinese economy, crude oil imports are still higher than in recent years. In contrast, US oil demand is well below historical averages. Crude oil inventories in the US are still running above historical averages, which have capped oil prices. But broad US dollar weakness and gradually improving risk appetite should support oil. On the negative side are the renewed concerns on the eurozone peripheral debt situation, interest rate hikes in Asia, and some lingering risk aversion, as well as increase in supply from OPEC (Iraq, Kuwait and Saudi spare capacity) and non-OPEC (gas liquids, Brazil) sources. Also, as and when there is a decline in inventories to below the five-year average, the liquefied natural gas story will start playing out. As expectations of an intermediate- to long-end of a forward curve keep determining the spot prices, our macro-pricing model suggests that the price of crude oil may average around $86 per barrel in 2011. Prices may have a difficult time breaking through to the triple digits; however, if they do, this will become a new floor of support. We are bullish on crude oil prices in the long term, even factoring in the substitution at higher prices of crude oil use as a percentage of global energy use – which may drop with a rise in crude oil price.