Commodities hit a home run amid worsening pandemic
17 May 2021, 02:00 pm
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This article first appeared in Capital, The Edge Malaysia Weekly on May 10, 2021 - May 16, 2021

WITH many countries grappling with the worsening pandemic as the number of Covid-19 cases continues to climb across the globe, a commodity boom has emerged amid the chaos.

The reasons for this rally, says OCBC Bank’s economist Howie Lee, are disruptions in the supply chains worldwide as well as pent-up demand for some of the commodities.

“China’s demand for raw materials continues to look robust. It is importing high amounts of copper and iron ore in particular. The US economy is also recovering faster than expected and consumers are driving petrol prices higher. Even if supply increases, we expect the marginal increase to be quickly snapped up by consumers and prices will remain elevated as demand appears to considerably outpace supply at this stage,” he tells The Edge.

“We continue to believe that commodities are undergoing a supercycle, consistent with what we called at the start of the year. The stagnancy we saw in March, in hindsight, was just a pause in the commodity rally, which now looks to have resumed.”

According to a recent Bloomberg news report, inflation risks are intensifying, with supply shortages multiplying.

“Signs of inflation are picking up, with a mounting number of consumer-facing companies warning in recent days that supply shortages and logistical logjams may force them to raise prices. Tight inventories of materials as varied as semiconductors, steel, lumber and cotton are showing up in survey data, with manufacturers in Europe and the US flagging record backlogs and higher input prices as they scramble to replenish stockpiles and keep up with accelerating consumer demand,” Bloomberg reported.

Saxo Bank head of commodity strategy Ole Sloth Hansen tells The Edge that with the Bloomberg Commodity Spot Index already up by more than 60% over the past year, there is no doubt that rising prices are being felt around the world. Last Wednesday, the Bloomberg Commodity Index, which tracks the prices of 23 raw materials, rose to its highest level since 2011 at 92.22 points.

The prospect of commodity prices continuing to rise over the coming years, thereby creating a so-called supercycle, will depend on producers’ ability to meet growing demand, says Hansen.

“The agriculture sector, which tends to have a relatively short cycle, where high prices in one year drive higher production in the next, is the sector most likely to respond, weather permitting. Industrial metals, many of which will be needed for the green transformation, are a different story, with inelastic supply struggling to meet growing demand.

“With this in mind, prices need to rise in order to incentivise higher production at a time when ore grades are coming down. Finally, the energy sector is a difficult one as we simply don’t know what the post-pandemic demand situation will look like — [whether] restrictions, working from home and green transformation will cut the potential demand growth and [whether] producers [will be] able to turn up production to meet growing demand, at least for a number of years to come.”

Rise in soybean oil, CPO prices

Year to date, crude soybean oil prices have risen 43% to 54 US cents per pound. According to an April 2021 report by Rabobank Agri Commodity Markets Research, new uses have superheated soy oil, none more than its inclusion as a feed substitute partly for scarce corn in China, which accounted for more than half of the 5% global growth in soy oil use this year.

“Rampant feed use is combining with food and biodiesel growth to pressure US 2020/21 ending stocks-to-use near 2012/13 lows of around 6%, implying three weeks of supplies and raising concerns for a timely US harvest,” says Rabobank.

“The vegetable oil trade generally faces mounting availability issues due to high demand, falling stockpiles, lack of farmer selling and uncertain resupply. Typical alternatives such as rapeseed, sunflower and palm oil are experiencing strong demand and are unable to relieve the scarcity pressure in soy oil.”

Meanwhile, the price of crude palm oil (CPO) futures has increased 12% year to date to RM4,044 per tonne.

Singapore-based independent online publisher of palm oil market news Palm Oil Analytics owner and co-founder Dr Sathia Varqa says prevailing supply tightness and the persistent rise in the prices of related oils are keeping palm prices elevated. “CPO futures have been rising rapidly on the back of not only prevailing supply tightness in palm but also in oilseeds (soybeans, sunflower seeds and canola) markets since the start of this year, with output languishing below potential, failing to replenish the fast-depleting stocks.

“Malaysian palm production is expected to be down 5.7% from January to April versus the same time last year, while stocks are set to suffer a year-on-year deficit for 21 months straight to the end of April.”

Confounding the problem of output is labour shortage in harvesting activities, leading to sub-optimal output this year, he adds.

“Annual [palm oil] output is revised lower by most analysts compared with the optimism at the start of this year. We project 2021 production at 19.1 million to 19.3 million tonnes. Last year, output was 19.136 million tonnes,” says Sathia.

In a note last Thursday, CGS-CIMB Research says it expects CPO prices to remain firm at RM3,500 to RM4,200 per tonne this month, amid low global edible oil inventories, which will take time to rebuild. “We maintain our view that palm oil supply will recover in the second quarter of 2021 as weather conditions normalise. We maintain our average CPO price forecasts of RM2,900 per tonne for 2021 and RM2,700 per tonne for 2022.”

Tin, copper and iron ore prices continue to surge

The price of tin, one of Malaysia’s oldest commodities, has surged a whopping 46% year to date to US$29,686 per tonne.   

“Tin prices have risen quite considerably this year, building on the back of the positive run in the second half of 2020. The initial move higher, which began in June last year, was prompted by production stoppages related to Covid-19,” International Tin Association market analyst James Willoughby tells The Edge.

“However, throughout 2020, demand started to return to the tin market after the initial Covid-19-related knock. This was helped by working-from-home and schooling-from-home trends, as well as consumers shifting their spending from travelling and entertainment to home electronics — particularly small and medium appliances.”

The combination of low production and growing demand saw prices rise considerably, he adds. “We have seen a recovery in most tin-using markets this year, while some smelters continue to have issues with their production. It is challenging to say when a price rally will end.

“At the moment, there is not a definite date for smelters to come back online or to start producing more tin. We do expect demand to come off slightly during the second half of the year as the world’s population transitions back to work and begins spending on travelling — rather than electronics — again.”

Meanwhile, the price of copper traded on the Comex has increased 29% year to date to US$4.52 per pound.

In an April 19 note, ING THINK Economic and Financial Analysis says the upside risks to copper prices could dominate the second quarter of 2021. “First, there hasn’t been a meaningful improvement to mine supply yet, and the situation is still vulnerable to disruption. China’s strong concentrated imports [in March] have provided little relief, and the multi-year low spot treatment charges have continued to squeeze smelters’ margins. Claims by some Chinese smelters to carry out maintenance work may further tighten the refined market and fuel the bullish sentiment.

“Second, demand recovery from major economies outside of China riding the ongoing restocking cycles and pent-up demand should remain a key theme throughout the year. The cyclical uplift in demand continues to support underlying consumption of copper from major end-users. The restocking cycle started from roughly end-3Q2020 by US manufacturers and wholesalers and has not yet come to an end.”

As for the price of iron ore, it has increased 18% year to date to US$186.94 per tonne.

In a May 4 report, S&P Global Platts says iron ore prices have risen to record highs in recent weeks largely because supply has not been able to keep pace with demand in China, where crude steel production has grown 30% over the past five years. “Unless China drastically cuts steel output — which seems unlikely as 1Q output rose 16% on year — or global iron ore supply increases significantly, it is difficult to see what will cause benchmark prices to retreat to consensus views of around US$100 per tonne in the next 12 to 24 months,” it adds.

A good run for oil, but a downturn for gold

It has been a fairly decent year for the energy market — the pandemic and its impact on travel notwithstanding — with Brent crude oil futures up 33% year to date to US$69 per barrel, thanks to a tightened supply and the robust demand recovery seen earlier this year when the number of Covid-19 cases started to decline.

“While we don’t see the risk of oil rising back above US$100 per barrel, the price looks set to stabilise at levels potentially higher than current prices just below US$70 per barrel. This is in response to an Opec+ growing influence as US shale oil producers will struggle to increase production at the pace seen during previous oil price rallies.

“We see Brent crude ending June at US$70 per barrel and ending 2021 at US$74 per barrel, with the main focus being virus versus vaccine, or in other words lockdowns versus increased mobility, the ability of Opec+ to control supply together with a slow recovery in US production,” says Saxo Bank’s Hansen.

Tamas Varga, a senior analyst at oil broker PVM Oil Associates, sees Brent crude ending June at US$75 per barrel. “In the second half of 2021, Brent crude should average around US$75 per barrel, driven by [the global] economic recovery, based on the wider availability of Covid-19 vaccines and diligent supply management by Opec+,” he says.

“The price strength ought to last well into 2022. I expect Brent to go above US$80 per barrel next year. The key downside risk is the unlikely fallout among Opec+ producers, similar to the one we saw in March 2020.

“The alliance has eight million barrels per day of spare capacity, so if their joint effort at balancing the market collapses, supply could easily rise well above demand. But again, this is unlikely.”

Gold, which was trading at US$1,786.87 per troy ounce last Wednesday, has declined 6% year to date, owing to a stronger US dollar and the prospect of higher interest rates returning.

Nevertheless, Saxo Bank’s Hansen sees gold prices climbing to US$1,825 per ounce at end-June, before peaking at US$2,000 per ounce at year-end. “Gold remains the most interest-rate- (US real yields) and dollar-sensitive commodity. So, with this in mind, we focus on developments on these fronts. Our reason for being bullish on gold is based on expectations that inflation will overshoot and not be transitory,” he says.

How long will this boom last?

Given the upturn in commodity prices, which started in the second half of last year, OCBC’s Lee thinks there are another two to three years left for the commodity rally to run. “Some commodities are likely to have a longer shelf life in this supercycle, especially those supported by the ongoing green theme, for example, copper and aluminium,” he says.

Saxo Bank’s Hansen says the main factors driving a commodity supercycle would be economic growth, speculation, supply bottlenecks and adverse weather developments. “The sector most exposed to a supercycle is metals and it potentially lasts more than five years, which is the minimum time it takes for new supply to be made available.”

 

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