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Commodity Monthly

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Market might be somewhat ahead of fundamentals

Thu, May 14 2009, 06:35 GMT
by Arne Lohmann Rasmussen

Danske Bank A/S

The last two months have been very impressive in commodity markets. Prices have recovered strongly: year to date copper prices are 44% higher and WTI oil is up 33%. The market is clearly starting to price that the global economy will recover from the current recession. Thus the market’s focus has moved away from recession, which was the main theme in Q4 08 and Q1 09, towards recovery.

For several months we have argued that global PMIs would turn up and push commodity prices higher. A turnaround in indicators would indicate that the sharp decline in economic activity in Q4 and Q1 was coming to an end. In fact, this has been happening: global leading indicators have continued to improve in all regions in April, pointing to a relatively synchronous recovery. Commodity-intensive Asia in particular has shown strong recovery signs. PMIs are rising above 50 and hard data for exports and production have also risen. This is not least the case in China, South Korea and Japan.

But also in the US, ISM manufacturing has continued to march higher, driven by further increases in new orders. And even Euroland PMI and German ifo have surprised positively.

Our economists continue to expect further improvements in leading indicators in the coming months. Lean inventories in combination with demand being lifted by substantial stimulus should pave the way for increases in production and commodity demand. But also, hard data have started to appear, confirming that we have passed the bottom. In China, fixed asset investments rose an impressive 30.4% year-to-date in April compared to the same period in 2008.

However, we are a bit cautious after the latest almost synchronous rally in commodities. There is a risk that some commodity markets have decoupled from fundamentals. The fundamental outlook represented by e.g. stocks for aluminium, nickel and lead has not changed significantly in the last month. Demand for oil in the US is also still pretty weak. It seems that the commodity market has run a bit ahead of the fundamental picture.

In our view, both base metals and oil are quite vulnerable if we get a set-back in risk sentiment. Hence, e.g. corporate clients might consider staying on the sideline for a while, awaiting a possible set-back in prices before hedging commodity exposure. However, as the turnaround in the global economy and sentiment looks real this time, one certainly shouldn’t expect to see significantly lower prices; the risk is that the upside we are looking for in Q4 occurs now. If the quick recovery in global PMIs is followed by an equal improvement in hard data, there is further upside risk for commodity prices in Q2 and Q3.

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Published on  Thu, May 14 2009, 06:41 GMT