Demand for commodities is still outpaced by supply, says Esty Dwek (pictured), Investment Strategist at HSBC Private Bank…
We believe that the improvements in global growth are not yet leading to a meaningful increase in demand for commodities, at a time when supply remains ample. As a result, we expect prices to remain capped for now, although the Chinese recovery should gradually support demand for industrial metals. We believe that increasing supply thanks to shale discoveries will weigh on oil prices in the long term, while gold prices still lack an upside catalyst.
Commodity prices have remained under pressure even as the global economy has recovered and the global growth outlook continues to improve. Indeed demand for commodities has not picked up meaningfully, in part because Chinese demand has not sharply rebounded. At the same time, the supply side has remained rather ample, limiting any price appreciation potential. In our view, this trend is likely to continue for some time yet as the global recovery is likely to develop only gradually and supply is likely to outpace demand growth.
Following years of strong performance and ever-rising prices, gold prices dropped 28% in 2013, one of the worst performances among any asset. Indeed, many of gold’s supports gradually dissipated throughout the year, and, today, we struggle to see what catalyst could lead to a sharp rebound in prices.
The global growth outlook continues to improve and much uncertainty has also been reduced by policymakers, sharply reducing demand for safe havens, and for gold in particular. The synchronised economic recovery continues and central bankers’ commitment towards their economies has been reiterated. Inflation remains subdued, and, if anything, policymakers are more concerned about disinflation than inflation, a trend that is unlikely to reverse in the short term.
The prospects for reduced global liquidity as the Federal Reserve winds down its quantitative easing program and a more robust USD are added obstacles to higher gold prices, in our view. Indeed, growth and monetary policy divergences are like to materialise between the US and the rest of the world, supporting gradual USD strength in our view. Weaker EM currencies versus USD are also of concern, as they make gold more expensive in local currency.
Finally, ETF outflows slowed towards the end of the year, but they have not stopped, and sentiment towards gold remains very fragile, with a loss of confidence that we think will take a long time to rebuild. Indeed, positioning has only improved from investors reducing their underweight exposure, not from new money flows.
Physical demand has been encouraging at the start of this year, but this may be due to seasonal effects such as the Chinese New Year and may fade in the coming months. Restrictions on Indian gold imports also remain a concern, and buying from EM central banks has been softer than expected in light of the fall in prices.
Industrial metals are typically closely tied to the global economic cycle and therefore sensitive to changes in growth and in demand – in particular from China. While we are seeing improvements in growth in all of the major economic blocks, it has been from weak levels and demand for base metals has not increased materially yet. In addition, since the Chinese economic recovery has remained relatively subdued and appears to be developing only gradually, the marginal uptick in demand has not filtered through to metal prices, although this may gradually change in the coming quarters, especially if some of the larger emerging market economies start to show signs of recovery as well.
While demand as only marginally increased, supply has continued to increase, in particular in copper, implying that the other side of the equation is not pressured either. Inventory levels remain relatively healthy both on the LME and in China, and we see little to support a significant rebound in prices in the short term. However, as the recovery continues to develop both globally and specifically in China, we believe that demand should continue to rise, gradually supporting prices.
In our view, oil prices are likely to remain range bound in the coming months as unsupportive demand and supply trends are balanced out. This is, to some extent, driven by lingering concerns about tensions in the Middle East and potential supply disruptions. In the long term though, we expect growing shale production – in particular from the US – to lead to softer oil prices.
Demand for oil has gradually picked up thanks to the global economic recovery and the gradual improvement in Chinese growth, although this has been from a low base. Chinese demand has risen, although not sharply, but demand from other emerging markets is likely to improve alongside their growth outlooks in the coming quarters. However, the increase we are seeing in supply is larger than the marginal increase in demand.
Supply is expected to remain ample in the coming months. Non-OPEC supply is growing rapidly, thanks to shale discoveries in the US, Canada and Brazil, and could even outpace the increase in global oil demand this year. Moreover, supply disruptions are expected to ease with the return of Libyan and Iranian oil in the coming months as geopolitical tensions ease, although rising violence in Iraq may remain a concern. However, oil producers are likely suffering from falling prices, and Saudi Arabia may decrease output to support its minimum price requirements if supply increase pressure prices.
Inventory levels also remain high compared to historical averages, even if they have fallen somewhat in recent months. This is adding to downward pressure on prices as the modest rise in demand is not strong enough to justify higher prices at this point.
We believe that the improvements in global growth will not yet lead to a significant increase in demand for commodities, and prices may therefore remain capped for the time being. Gold continues to lack upside catalysts while shale discoveries are likely to weigh on oil prices in the long term. However, with the gradual recovery in China, we believe that demand for industrial metals is likely to rise in the coming quarters, supporting higher prices.