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Commodity Monthly

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China goes shopping

Tue, Apr 7 2009, 13:32 GMT
by Arne Lohmann Rasmussen

Danske Bank A/S

Optimism seems to have returned to commodity markets. Since the beginning of March, we have seen significantly higher prices for most commodities. Brent oil is above USD51/bbl and LME copper is above USD4,300/t. Prices are still well below their 2008 highs but we have seen a definite shift away from the recessionary pricing seen at the beginning of the year.

Commodities have been boosted by several factors. We have seen a strong performance in global equity markets boosted by higher risk appetite and the dollar has weakened. In addition, we believe higher prices can also be attributed to an improved economic outlook. The world economy was more or less in freefall in Q4 08 and in the first two months of 2009. However, as we wrote in the last issue of Commodity Monthly, we have now seen clear signs of stabilisation in the demand outlook and the improvement has continued in March and the beginning of April.

Once again China takes the limelight. PMI for China compiled by NBS showed a jump from 49 in February to 52.4 in March, and even more importantly we saw new orders jump to 54.6. The Chinese PMI report suggests that Chinese industrial activity is again expanding and even export orders seems to be expanding, albeit demand is primarily driven by domestic demand. In general, global leading indicators have continued to improve over the past month with further improvement in the balance between orders and inventories. A rapid decline in inventories means production will soon have to rise in order to meet demand. In fact, production plans in Japan already point to rising production in March and April. In the US, the ISM index surprised on the upside and details of the report showed a strong increase in the new orders index. Euroland PMI also surprised positively but, as expected, the improvement is happening more slowly here. We continue to expect further improvement in leading indicators going forward as stimuli should improve demand and inventories have become very lean globally. We have also seen new steps from the global community to tackle the global recession. The G20 meeting last week agreed to quadruple the IMF's financial capacity with a USD1trn commitment. It should help the battered emerging markets and help kickstart the global economy together with the significant global easing in monetary and fiscal policies.

However, we are not out of the woods yet. The surge in commodity prices in Q1 09 might look a bit exaggerated given that we are just starting to emerge from a global recession. The commodity rally might have gone a bit too far for now. We argue that the price risks for commodities such as oil and copper now looks more two-sided. For the risk-averse client we continue to recommend hedging commodity exposure not least for latter part of 2009 and the beginning of 2010. But one might also consider waiting for a likely setback in prices. However, one should certainly not expect to see new lows in prices. But a setback of 5- 10% should not be ruled out. However, any drop in the spot prices might very well be accompanied by steeper forward curves. The market has definitely bought the idea that going forward prices will continue to rise as the economic stimuli boost the global economy. In that respect, note that the December 2011 Brent crude oil future is currently trading above USD70/bbl. We expect that level to be reached end-2009.

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Published on  Tue, Apr 7 2009, 13:39 GMT