Commodities Update: Yet To Return From Holiday‏

Commodities have struggled to move higher since the start of 2013, despite improving Chinese and U.S. data and decent risk appetite, which has supported other risk assets, notably equities. Energy, metals and grains prices are lower than at the start of 2013, begging the question why have commodities failed to perform? We see three main reasons for this underperformance, which should be alleviated to some extent in Q2.

First, while cyclical conditions have improved, weak spots have also surfaced. While China avoided a hard landing, its recovery has been less sturdy and less commodities intensive than anticipated around New Year. Indeed, the pickup in physical buying from Chinese manufacturers that many (including us) were looking for after the Chinese Lunar New Year never really materialised. Also, while the U.S. growth engine has certainly shifted into a higher gear, it has become increasingly evident that a soft patch as a result of the heavy federal budget cuts is unavoidable. As a result, commodities have not been granted an outright positive demand background to move unilaterally higher.

Second; uncertainty following the dizzy Italian election outcome has hit risk appetite and, not least, the EUR and the Cyprus crisis has not helped to lift sentiment either. Rising speculation on when the Fed will initiate its exit from QE has also held a hand under the USD. The move lower in EUR/USD has thus weighed on commodities partly from a denomination point of view (for USD-traded products) and a partly from a risk sentiment point of view. In this respect, it is interesting to note that speculators have shred crude, copper, gold and corn alike of late, hinting that it may not take much bullish news for prices to start recovering from here. Third, supply conditions have generally surprised on the upside. Non-OPEC crude oil production has edged higher as North American shale supplies add and maintenance in key areas has ended. Although the Saudis have cut production as a result, other OPEC countries have ensured that output from the cartel is still running above 30mb/d. We have argued for a while that it was simply a matter of time before Chinese imports of copper picked up, as booming bonded warehouses had to be run down first. This has not happened. While there is little visibility on the amount of metal in bonded warehouses, it is now clear that recent months have seen a significant ramp up in global copper production, LME stocks have surged to post-crisis highs and future supply prospects look much brighter than they did in the autumn. Notably, the International Copper Study group (ICSG) now projects 2013 will see the first refined copper market surplus since 2009. Finally, for grains, US weather conditions have improved and while drought is still an issue in some areas, recent prospective plantings data point to a marked recovery in production of most grains this season.

Our forecasts for Q1 have generally proved too optimistic and we look to revise the level of our forecast profiles lower for most products. However, we still expect to see a peak in commodity markets in Q2, as the underlying cyclical picture continues to improve but much depends on the euro zone: if the ECB goes for a rate cut, Italy remains without a government and/or the debt crisis resurfaces, commodities stand to miss out on the H1 risk recovery altogether. From the summer conditions stand to deteriorate as an improving supply outlook, softer demand from China and markets eyeing the Fed exit should weigh on the complex.

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