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Commodity Monthly

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Signs of improving demand − but huge stocks

Thu, Feb 5 2009, 17:15 GMT
by Arne Lohmann Rasmussen

Danske Bank A/S

Over the past couple of months we have argued that the significant supply reaction currently being seen in many commodities - most notably in oil, aluminium, nickel and zinc - would stabilise prices and eventually push prices higher. An expected improvement in not least the growth outlook for Asia and the US is also a supportive factor going forward in our view.

There is little doubt that supply cutbacks and cuts in spending plans continued in January in the commodity sector. This week, Marathon oil announced that capital spending in 2009 would be 24% lower than in 2008. Marathon Oil, BP and Dutch Shell have now all reported losses in Q4. Considering the price development so far Q1 does not look any better. Weak earnings in many commodity companies and the credit crisis do not bode well for capital spending in 2009 and 2010. We have also seen a string of production cutbacks in e.g. aluminium. According to CRU, more than 13% of 2009 production is currently closed down, as 60% of all aluminium is currently produced at a loss. In addition, in zinc, oil and nickel, companies are cutting back on spending and production to minimise losses as marginal costs are higher than current prices. The financial crisis has also taken its toll on spending plans in base metals. Funding is very difficult not least for minor producers. In oil, OPEC continues to cut back production and another cut in quotas is likely in March. However, if OPEC is going to be successful in bringing oil prices higher, quota compliance should be improved. We base our forecast on improved compliance.

Producers are facing a tough job. The stock build over the past couple of months has been much stronger than foreseen by most analysts. The near stalling in the global economy in Q4 - not least in construction and stainless steel production - has pushed aluminium and nickel stocks through the roof. We estimate that the reported days to stock consumption ratio has jumped to 85 days in the current quarter from 53 days in Q3 08. Oil stocks are also higher. The so-called forward demand cover in the OECD area rose to 56.4 days in November and it could hit 58 days this year. OPEC prefers a ratio of around 52. The bottom line is that although we currently see significant production cutbacks in many commodities, the stock overhang that has to be worked off in the coming quarters is significant. The higher-than-expected stock build is the main reason why we in general have revised our 2009 forecast downwards slightly.

It is not all doom and gloom for the commodity business. Lately, we have seen very encouraging (albeit tentative) signs that the Chinese Dragon has reawakened. Chinese PMI jumped from 41.2 in December to 45.3 in January. We have also seen dry bulk rates rising strongly over the past couple of days on the back of China once again purchasing iron ore. Also apparent demand for copper seems to be jumping. The obvious destocking that we have seen in several commodities in China seems to be coming to an end. If the positive news continues to flow from Asia it will be very constructive for the commodity complex. We keep our cautious positive view on commodities for H2 09 based on the assumption that Asia and the US will move out of recessionary territory during the period. Hence, despite the fact that many commodities are trading in contango, we recommend investors hedge commodity exposure at the current depressed price level.

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Published on  Thu, Feb 5 2009, 17:22 GMT