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Commodity Monthly

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Economic recovery to push prices higher in Q4

Wed, Jun 17 2009, 15:05 GMT
by Arne Lohmann Rasmussen

Danske Bank A/S

Commodity markets have been very impressive over the past three months. Prices have recovered strongly. Oil has topped USD70/bbl, copper is trading above USD5,000/t and even aluminium is up close to 30% from the bottom.

As we wrote in the previous edition of this publication, there is little doubt that the market is now pricing in an expectation that the global economy will recover from the current recession. We think the market is right in this presumption. Last week our Economics research team released new economic forecasts. Our economists argue that lean global inventories and record stimuli provide a powerful cocktail for growth. It continues to expect global leading indicators to improve and argues that the global recovery in 2009 is likely to be stronger than expected by consensus. The global recession is expected to end in Q3 09.

If this quite upbeat scenario materialises, it will – everything else being equal – be a very positive factor for commodity prices. That said, it could also already be reflected in the current pricing in many financial markets including commodity markets.

There is little doubt that the fundamental picture has improved in many commodity markets. In oil OPEC has shown strong commitment to reduce the current stock overhang, while in metals China has continued to vacuum the global market for base metals, and the numbers coming out of China are surprisingly strong. All in all it seems that commodity demand is not just stabilising but actually picking up – albeit a much lower level than before the crisis.

However, we have to acknowledge that the market in many aspects seems to be ahead of current fundamentals. Global oil stocks are still significantly above normal levels. OECD forward demand cover was running at 62 days in May, which is 7.5 days above the 2008 level and close to 10 days above the preferred OPEC level. US demand is also quite weak. The latest weekly data from the EIA showed that total products supplied to the US were down more than 10% y/y in the beginning of June.

In our view, the market is pushing oil prices higher in anticipation of a tighter market later this year when the OPEC cuts start to feed through into stocks and demand recovers. The story is much the same in other commodity markets. Prices are pushed higher in anticipation of an improved market balance. But one should always be cautious when markets are moving on expectations alone. There is a risk that markets once again start to focus on current fundamentals. Commodity prices could be quite vulnerable if there is a setback in risk sentiment. It is never healthy for commodity prices in the long run if price movements have to be explained by speculative investors that are in the market to gain inflation and dollarweakness protection.

Hence, hedging clients might consider staying on the sidelines for a while awaiting a possible setback in prices before hedging commodity exposure. However, as the turnaround in the global economy seems for real this time, one should certainly not expect to see significantly lower prices, and the risk is that the positive sentiment continues and the market just neglects the current weak fundamentals. If the recovery in global PMIs is followed by an equal improvement in hard data, there is further upside risk for commodity prices in Q4 and in 2010. Furthermore, one should not underestimate the power of investors purchasing commodities to position for a global recovery. Investors might very well have the ability to ‘sit and wait’ for better fundamentals to prevail later this year. In other words, there is certainly a risk that the long-awaited setback in prices will never materialise to any significant degree.

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Published on  Wed, Jun 17 2009, 15:10 GMT