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Supply To Determine Commodity Price Outlook

Most mining and energy commodity prices rose in 2016-17, with coking coal, thermal coal and zinc leading the charge. Some mining commodities bucked the trend, like nickel, oil and gold.

Stronger Chinese demand was a major driver of higher prices through the year. China accounts for between 40% to 60% of global consumption of the key mining commodities. China’s capital spending, especially on infrastructure, has remained elevated since the beginning of 2016, with the Government resorting to this spending to avoid a hard economic landing.

?But analysts from the Commonwealth Bank expect commodity prices will fade through 2017-18 as China’s demand for mining commodities wanes following national elections in the fourth quarter of 2017 and a Government reshuffle in the first quarter of 2018.

“As China’s demand slows later next year, supply side dynamics for individual commodities will increasingly determine price movements. Where supply is challenged for a certain commodity, like copper, the downward pressure on prices will be more limited,” said a July research note from the Commonwealth Bank’s Global Markets Research division.

“Where supply is still expected to grow notably, like iron ore, we expect prices to retreat more aggressively,” said the research note.

Oil prices to trend higher

Despite oil prices hovering near nine month lows, the Commonwealth Bank expects prices to trend higher in coming months as OPEC cuts supply.

“We see oil prices lifting by year end as members of the OPEC-led deal look to reduce exports in line with production. We see oil prices retreating after the [OPEC] deal expires at the end of the first quarter of 2018 on expectations that deal participants will struggle to execute an exit strategy that slowly brings on the oil supply that is currently sidelined,” said the bank.

Importantly, US shale production will also cap price rises. “US shale oil supply remains the other most important structural driver for oil prices. Saudi Arabia and OPEC have underestimated just how quickly US shale oil producers can respond to profit margins.”

US oil producers now account for around 10% of global oil supply and are continuing to lift supply, “showing that shale producers were still profitable in the US$40-50/bbl.”

Oversupply could weigh on iron ore

Iron ore was one of the worst performing commodities in the second quarter of 2017. Prices started the June 2017 quarter at around US$80/ton, before tumbling to a low of US$53/ton on June 13, 2017. Prices rebounded to finish the quarter at US$65/ton. The late surge in iron ore prices reflected restocking demand, a shortage of medium and high-grade ores and high production margins, the bank said.

“We continue to see the iron ore rally gaining momentum in the short run as Chinese steel mill margins remain elevated. China’s steel sector has a propensity to erode margins quickly due to the highly competitive nature of the industry. That behaviour looks set to continue given that spare capacity is not a constraint.”

But over the longer term, iron ore prices are expected to fall as Chinese demand eases.

“While we are positive on iron ore prices so long as Chinese steel mill margins remain high, we still expect iron ore prices to decline to US$45/ton by mid-2018. Our forecast is driven by rising seaborne supply, high stockpiles and China’s steel demand eventually fading.”

Coal prices to dip

Premium coking coal prices have eased recently to around US$150/ton after spiking to US$314/ton in mid-April following Cyclone Debbie in March.  The Commonwealth Bank estimates that coking coal markets will lose around 3% to 5% of global market supply as a result of the cyclone. Australia is likely to claim back some of that lost production through winding down stockpiles and higher output rates.

But coking coal prices will eventually trend downwards as Chinese demand eases.

“We see China’s coking coal imports slowing by mid-2018 as debt fuelled investment fades following China’s election cycle. We expect premium coking coal prices to gradually decline to US$100/ton by the middle of next year. Any further supply disruptions will add upside risks to our price forecast.”

Spot thermal prices are expected to fall too.  Spot thermal coal prices declined around -5% in the June 2017 quarter to around US$84/ton and are forecast to fall further still.

“We believe that thermal coal prices will average US$69/tonne in 2017-18 given the price range indicated by China’s National Development and Reform Commission  (NDRC). We think stronger supply, particularly from Indonesia, should see prices fall.”

Gold to fall as rates rise

Gold prices moved sideways in the closing quarter of 2016-17 as safe haven demand was offset by the prospect of rising US interest rates. The Commonwealth Bank analysts predict that a higher US Federal Funds rate next year will eventually push gold prices lower.

“Gold prices and US 10-year real [bond] yields have historically had a tight inverse relationship. Lower yields increase the appeal of non-US interest bearing assets like gold. We believe this relationship will continue to hold. Therefore a higher Fed Funds rate will drive yields higher and gold prices lower,” the research note said.

“While we upgrade gold prices in the short term given stronger safe haven demand, we still believe that higher US interest rates will eventually weigh on [gold] prices”.

Gas prices to weaken over the longer term

The bank expect US natural gas prices to average US$3.03/mmbtu in 2017-18, up 8% from its previous forecast. Over the longer-term, prices are forecast to be much lower, with the bank’s long-term real forecast down around -18% to US$2.61/mmbtu, with increased supply weighing on demand.

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The content of this information does in no way reflect the opinions of FN Arena, or of its journalists. In fact we don't have any opinion about the stock market, its value, future direction or individual shares. FN Arena solely reports about what the main experts in the market note, believe and comment on. By doing so we believe we provide intelligent investors with a valuable tool that helps them in making up their own minds, reading market trends and getting a feel for what is happening beneath the surface. This document is provided for informational purposes only. It does not constitute an offer to sell or a solicitation to buy any security or other financial instrument. FN Arena employs very experienced journalists who base their work on information believed to be reliable and accurate, though no guarantee is given that the daily report is accurate or complete. Investors should contact their personal adviser before making any investment decision.



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