Global commodity markets hit by demand slowdown

Global commodity markets are currently going through a period of turmoil. The tug-of-war between supply and demand is palpable. Several uncertainties that impacted the market in recent years continue to play out differently.

In the last two years, markets were driven by a series of concerns and uncertainties covering global economic growth, geopolitical instabilities, contrasting monetary policies by different countries, currency gyrations and weather. There is no denying that a substantial part of the commodity price boom was liquidity driven, thanks to the US Fed’s ultra-liberal monetary policy.

At the same time, since 2013, the world has witnessed supply growth across commodities – metals, bulks, crude and agriculture. Higher supplies, especially of growth-driven commodities, were steadily absorbed even as the excess liquidity boosted commodity prices in the form of speculative capital.

Again, led by the US, steadily improving growth signals helped support commodity demand. Agriculture commodity prices were substantially driven by a huge rebound in harvests (corn, wheat, oilseeds, cotton, sugar, etc) following generally benign weather across the globe.

The situation has altered dramatically in recent months. Geopolitical tensions that threatened crude supplies have abated in recent months. If anything, supplies of energy products are rapidly expanding. Crude oil prices have dropped by 20 per cent.

With normalisation of the US monetary policy (following tapering of quantitative easing), liquidity continues to shrink. Availability of easy money, especially the dollar, has turned tight. From 1.38 to the euro at the beginning of the year, the dollar is substantially stronger currently at 1.27. If the US growth continues, the greenback could rise further.

So, reduced geopolitical tensions, shrinking liquidity, stronger dollar and benign weather have combined to push commodity prices down.

Given the fairly comfortable supply situation, speculative capital stands substantially withdrawn from the market. In the bourses, speculative longs have exited en masse.

While supplies are comfortable, demand concerns have emerged. Although the US is the engine of global economic growth and continues to record positive uptick in macro data, there are concerns elsewhere.

European recovery continues to be enervated and industrial growth risks a decline. Japanese growth seems to have lost momentum in the last two quarters. As for China, despite relatively high growth, there is a general slowdown especially in the construction sector that is acting as headwind.

Prices slide

Across the commodities complex – whether energy products, industrial metals, base metals or agriculture – prices have dropped by 10-20 per cent. Some commodities are trading at or even below the cost of production.

From a long-term perspective, it is not a healthy situation. It is sure to hurt producers and reduce the incentive for further investment.

In some cases, production cuts will be resorted to. All these will have medium to long impact on future commodity supplies and prices. Countries that import and consume large quantities of various commodities – energy products, industrial and base metals as also agricultural goods – have reason to be happy about falling commodity prices; but the feel-good factor may not last long.

The market will rebalance faster than many can imagine. Indeed, rebalancing has already started in bulks and metals. Iron ore, coal and copper are prime examples. In agriculture, growers may not have sufficient incentive to continue to grow larger quantities next year.

They may compromise on input management. Weather continues to be an uncertain factor.

Given the current fundamentals, amongst metal, nickel and zinc prices may be an exception with the ore stock of the former already at critical levels.

As for Brent crude, there is belief that geopolitical risk fatigue may be driving prices down at the moment while risks of a flare up continue to lurk in the background.

So, on current reckoning, weak demand conditions may put paid to any hopes of a sharp rise in commodity prices next year with a few exceptions.

It is in this latest uncertainty that gold has found a saviour with prices bouncing back above $1,200 an ounce; but it is not a sustainable given the weak physical market demand.