Commodities: tightening supply conditions ahead

Despite an encouraging start, 2018 turned was a difficult year for commodities, with all commodity sectors yielding negative returns.

A more hawkish tone from the Fed, US-China trade tensions, and moderating activity data raised fears about the health of the global economy.

Looking forward however, fundamentals for gold, copper and crude oil all point to tighter market conditions and better price support this year.

The gold price in particular was driven sharply lower last year by US dollar strength relative to G10 and emerging market currencies. 

Global growth jitters

Concerns that the Fed might have to hike rates to above the neutral rate and towards restrictive levels, as indicated by the Fed dot plots, played a key role in keeping the gold price restrained.

However, growing uncertainty over global growth and the increasing risk that the US Federal Reserve is approaching a neutral policy may provide near-term support for gold prices in the first half of 2019.

Regarding copper, concentrate exports from Indonesia’s Grasberg mine, the world’s second-largest copper mine, are forecast to plunge this year because of a lag in output as operations move from open pit to underground mining.

Once sentiment shifts based on Chinese stimulus or a negotiation of a US-China trade deal, this implies conditions favouring higher prices.

With the Fed nearing the end of the tightening cycle whilst the PBoC provides some stimulus, expectations of a weakening US dollar and strengthening emerging market currencies might in addition remove a big headwind for copper prices.

Copper curve

The market appears to be tightening quite substantially, with inventories continuing to draw across LME, Shanghai and bonded Chinese warehouses, while Chinese refined copper imports remain robust and the curve is essentially flat (figure 1).

The market will likely be in a deficit for 2019, so the fundamentals of the copper market appear to favour stronger prices once the macro backdrop becomes less of a worry.

Curves in contango

Whilst the recent record-setting oil price correction was triggered by a deteriorating risk appetite, it was made possible and intensified by a steep increase in OPEC+ and US shale output ahead of the implementation of US sanctions on Iran.

Moving forward, the production cut by OPEC and Russia together with modest demand growth implies a market imbalance in the first half of the year, supporting prices.

Later in the year, Permian production will likely surge, as new pipelines increase take away capacity. With export terminals not having sufficient capacity to clear the excess supply, the marginal US barrel will be landlocked in North America, increasing the Brent-WTI differential. As far as international crude oil is concerned, expiring waivers leading to tightening sanctions against Iran might mitigate the increased supply.

Crude oil curve

For now, the crude oil price curve is in contango (figure 2), which implies a negative roll yield.

Investing in oil will become more attractive once the curve moves into backwardation.