Sector review: Commodity prices show short-term blip

Global commodity prices have fallen across the board in the July-September quarter and more noticeably in September. The fall in commodity prices in the last three months has been between 6 and 36 per cent over the highs recorded in 2014.

Natural gas has fallen 36 per cent over its February high of $6.15 mmbt and iron and ore hit five year low at $597 a tonne.

Crude oil declined to a two-year low, copper slipped to its lowest in four months, aluminium fell to $1,960, a two-month low and Zinc declined more than six per cent to its June 2014 level of $2,226. Gold for December delivery dropped to a nine-month low of $1,215.40 a troy ounce, while silver at $17.67 an ounce, dropped to over four years low.

In the interim, with money flowing back into commodities, in the first half of CY14, the market tried to reverse the downtrend that we have been witnessing since 2011 (see table).

What impacted commodity markets since July has been an anticipated slowdown in China and the US Federal Reserve raising its outlook for interest rates.

The International Monetary Fund (IMF) downgraded growth estimates for 2014 and 2015 for most major economies. In July, the IMF downgraded its economic forecast, estimating the world economy would expand 3.4 per cent this year, rather than the 3.7 per cent it had previously predicted, due to weaker growth in the US, Russia and developing economies.

The India strategy reports by Motilal Oswal Securities on melting commodities hinted at wide-ranging implications on Indian economy, government finance and external balances and multiple sectors.

Analysts expect the direct beneficiaries of declining commodity prices to be oil marketing companies, upstream oil and gas, auto and financials.

However, the global commodities report by HSBC Global Research indicated that commodity prices are 115 per cent above their 1990s average, despite falling from their 2011 peaks. Notwithstanding slower growth in emerging economies, global commodity prices remain structurally high: while they have fallen by 18 per cent since 2011, they are still above their 1990s average in inflation-adjusted terms.

The price trend over the past three decades for the major commodities appears to be more stable for oil and base metals. Oil prices peaked in 2008, just prior to the failure of Lehman Brothers, before falling sharply. Over the past four years, prices have been relatively stable, averaging around 500 per cent above their 1990s average.

Aluminium prices doubled from 2003 through 2005, but output increases were such that the market has been in a state of oversupply since then, while copper prices have risen by 240 per cent in real terms.  Though these two commodities had been one of the strongest performers since the 1990s, their prices have drifted slightly lower over the past few years as the market has moved into a small surplus.

Current prices of iron ore are, however, close to the marginal cost of production for a large range of producers, which is expected to prevent prices from falling too much further, says analyst.

HSBC's metals team expects prices to rebound slightly over the next year, averaging $109 per tonne over 2014 and $105 per tonne over 2015 before stabilising around $100 per tonne.

Nevertheless, after a disappointing 2013, the commodities market had outperformed the S&P 500 Index by more than 4 percentage points and 10-year Treasury bonds by more than 6, indicates a research report by US global investor.

Leading the rally in the first six months of the current calendar year (CY14) was nickel, delivering a 37.14 per cent return, followed by copper (10.09 per cent) and crude oil (8.04 per cent). Nickel climbed more than 55 points to settle close to $19,000 per metric tonne. Gold jumped 38 percentage points to $1,327 an ounce, and crude oil rose 5 points to $112 per tonne.

Although crude is not one of the top leaders in the first half, it deserves a special notice. Its 7.06 per cent annual return is closing in on the 7.19 per cent return in 2013, when oil was the second-best performer. Because of unrest in Iraq, North Sea Brent crude has set a record for trading between $107 and $112 a barrel for 12 consecutive months. 

In the past 10 years, a significant fall in commodity prices was seen in CY2008 on account of failure of Lehman Brothers.  Lead fell the most to 62.52 per cent, followed by copper (down 56.53 per cent), nickel (down 55.37 per cent) and crude oil (down 53.53 percent). Gold, however, survived in 2008 commodity meltdown, gaining 5.77 per cent (see table).