December 22, 2014

2014 Commodity Markets Review : A year of sharply contrasting price moves

Commentary by Robert Balan, Senior Market Strategist and Alessandro Gelli, Commodity Analyst

“Nothing exists without its opposite.”

Chris Crutcher

What a year! As 2014 is ending, it is now time to review what happened in commodity markets. Contrasting with a relatively quiet 2013, the volatility made a comeback through the front door this year. Commodities experienced strong price actions in 2014. These were triggered by several factors, which contributed first to higher raw material prices in the first part of 2014 and then led to an opposite price movement in the second part of the year. The key drivers this year were reduced concerns on the Chinese economy, geopolitical tensions, the sharp rise in the US Dollar as the Fed adjusted its policy, a sharp decline in inflation expectations, and OPEC inaction. These factors occurred while global growth remained stable at 3.3%, similar to that of 2013 as stronger economic activity in the US offset lower activity in Europe and in some emerging countries.

In the first part of the year, concerns about supply or supply-disruptions in all commodity sectors and lower real interest rates, while the Chinese economy showed signs of stabilisation, were the main drivers behind the good performance of commodity prices. Fears of El Nino and a drought in Brazil led to the outperformance of the agriculture sector. The precious metals sector experienced a strong upward move in Q1 2014 due to an oversold market, lower real interest rates and a supportive US Dollar. In Q2 2014, strong US growth, the Indonesian ban on ore exports and reduced concerns about China contributed to an important rebound of the base metals sector. The energy sector also benefited from higher tensions in the Middle East and between Russia and Ukraine. This allowed for a good performance of commodity indices in H1 2014 as reflected by the 7% upward move of the Diapason Commodities Index®.

However, commodity prices moved in the opposite direction in the second part of the year. The sharp US Dollar rally and the decline in inflation expectations in Q3 2014 triggered the first downward move in commodity prices. The impact of the stronger US Dollar had a broad effect on commodity markets, as reflected by the stronger correlations between commodity sectors during Q3 2014 (see charts of the week). The US Dollar then continued to rise but on a slowing momentum. This supported the sectors that are most sensitive to the greenback moves such as agriculture and precious metals. Some sectors have in fact already found bottom — base metals in March, agriculture at the end of September and precious metals at the beginning of November — so any more damage from a further US Dollar strength may be limited at this point.

A steep fall in global commodity demand expectations was the other main factor which drove the decline in commodity prices in the latter part of H2 2014. This came about as growth expectations in China, Europe and Japan looked weak following lacklustre activity data. It also did not help that supply in the oil sector proved to be ample — supply cuts were urgently needed to rebalance the oil market. In its November meeting, OPEC surprisingly decided to keep its production-target unchanged as it wanted to keep market share and aimed to force an adjustment of supply from non-OPEC producers and especially US oil companies. The OPEC inaction led to an adjustment of the oil price structure, which started to affect some oil producers. The DCI® Energy Index fell by 38% between January and the end of the third week of December 2014. The energy sector’s performance diverged significantly from that of the other sectors. The DCI® ex-Energy Index indeed fell by 3% during the same period. Despite some high volatility throughout the year, the agriculture sector’s performance was almost flat at -0.1%. But this was enough to make it the best performer among commodity sectors, followed by base metals (-4.1%) and precious metals (-4.4%).

Oil prices made a significant downward move to stress levels for many oil producers, but are still looking for a floor. The base metals sector, which did not make a new low in the second half of the year, is still showing signs of hesitation due to the uncertain situation in China. On the other hand, the precious metals market appears healthier, with the confirmation of the year-low made in early November. Agricultural commodities may have experienced one of the most interesting price actions, with the strong divergences of the grains, soft and meat sectors and also the major contrast in the sector performance between the first and the second half of the year .

The elements which marked 2014 are laying the foundation for 2015, which could offer interesting opportunities after this year’s large adjustments. These opportunities will be presented in the next Diapason Commodities Insight Weekly, which will be published on Monday January 5th 2015 as we will start presenting the commodity outlook and the macro drivers for 2015.

Warmest greetings and best wishes for the New Year

2014 Commodity Sectors Review
 

AGRICULTURE

Fears of El Nino, important drought conditions in Brazil and some specific commodity related issues contributed to a significant rise in agricultural prices in the first part of 2014. The DCI® Agriculture Index rose by 17% between January and the end of April. However, the significant rise in the US dollar, lower concerns about El Nino and confirmations that the grain and oilseed crops could reach exceptional levels this year contributed to a significant decline in grain prices between April and the end of September. During this period the DCI® Grain index fell by 31%.

On the other hand, the decline in grain prices was mitigated by higher soft and meat prices. Arabica coffee price rose by 100% between January and early October 2014 as the Brazilian crop suffered from an important drought. Strong demand and worries about the possible contagion of Ebola in Ghana and Ivory Coast contributed to the 24% upward move in cocoa prices from January until the end of September. The porcine epidemic diarrhoea virus, which decimated 6% of the hog population in the US, and low cattle head count ─ the lowest since the 1950’s at the beginning of the year ─ contributed to a significant outperformance of meat prices. The DCI® Meat index rose by 22% year-to-date.

In turn, the good performance of the meat sector added support to grain prices. Strong demand for animal feeds and logistical constraints in the US contributed to the rebound in grain prices at the end of September. In Q4 2014, another supportive factor arose for the grain market. The rubble’s collapse and consequent rise in local food prices increased worries that the Russian government may implement export restrictions on grains, in order to keep the domestic market well supplied, adding upside pressure on grain prices. Wheat prices rose by about 35% between the end of September and the third week of December.

PRECIOUS METALS

In the first part of 2014, the DCI® Precious Metals index rose by almost 10% driven a supportive US Dollar, lower real interest rates and oversold conditions by a major strike in South Africa. The 5-month strike, which ended in June 2014, took off over 1 million ounces of platinum from the market — 24% of 2013 mined supply in South Africa, the world’s largest platinum producer. This also accounted for 14% of global mined platinum production in 2014, boosting platinum prices by 10% between January and the end of June 2014. The macro-conditions also contributed to the good performance of the precious metals sector. Following a rise for most of 2013, real interest rates declined in the first half of the year. The US Dollar also declined during this period. But another important contributor to the precious metals rally was short covering as oversold conditions had clearly been reached at the end of 2013 as total known ETF holdings of gold fell by 33% throughout 2013 and short speculative positions stood close to record levels.

This contrasted with the second half of the year when the decline in inflation expectations and a sharp rise in the US Dollar had a significant negative impact on the sector. The euro-dollar indeed declined by about 10% during this period and reached its lowest level since mid-2012 at the beginning of December. It suffered from growing market expectations that the US Fed could increase interest rates sometime in 2015 as the US economy continued to show signs of strength, while, on the other hand, the ECB indicated its intention to expand its balance sheet with the implementation of a “European QE program” expected for next year. This could increase expectations of stronger growth in Europe, while the US economy has continued to expand, reducing demand for gold as a safe haven asset. Precious metal prices made their bottom at the beginning of November as the US Dollar rally lost its momentum and Indian gold demand accelerated, allowing gold prices to move above the $1200 an ounce level in December.

BASE METALS

In the base metals sector, the key element in 2014 was the shift in confidence over China. Indeed, in 2013, the DCI® Base Metals index had fallen by almost 16% on fears of a Chinese hard landing. This has never materialised. In fact, the economic situation stabilised, allowing the country to keep its GDP growth at around 7.4% in the first three quarters, only slightly down from the same period last year (7.6%), while some economists expected in mid-2013 a Chinese GDP growth below 7% for 2014. The better than expected growth was reflected by the mild performance of base metals throughout the year.

In the first part of the year, base metal prices rose, driven by the Indonesian ban on ore exports, which affected mineral ore supply for some base metals and especially nickel. Nickel prices indeed rose by almost 50% from January until mid-May. The performance of the base metals sector lost its momentum in June, following the financing probe in China on some companies which used base metal inventories as collateral against multiple loans. This contributed to a significant reduction in base metal imports from China as banks tightened credit conditions. Inventories of base metals were also transferred from non-transparent warehouse to the visible LME warehouse, increasing the LME inventories for some base metals. Moreover, weaker economic data in China in September then contributed to an important consolidation in base metals prices in Q3 2014. Prices then recovered with the exception of copper, which lagged the base metals sector in 2014. In Q4 2014, copper prices fell to their lowest level since 2010, due to growing evidences that the copper market would remain in surplus until 2017, while other base metals are likely to experience growing balance deficit in the coming 2-3 years.

Aluminium and zinc indeed benefited from these expectations of large deficits in the coming years. In 2013 and early 2014, prices for these metals also stood below the incentive price required to build new capacity. Furthermore, strong demand for these metals and lagging supply growth was reflected by lower inventories, contributing to the outperformance of these metals within the base metals sector in the second half of the year. In mid-December 2014, LME aluminium inventories reached 4.3 million metric tons, the lowest level since November 2010 and down by 22% from the record high level reached in January 2014, indicating that the large inventory that had been built during these past four years has been erased in only 12 months.

Targeted interventions by Chinese authorities also contributed to push base metals prices higher in the first part of Q4 2014. However, this was not sufficient to offset the impact of the sharp decline in oil prices at the end of the quarter, as it reduced cash costs for producers. This especially affected aluminium prices as energy typically accounts for 40% of total cash cost for aluminium.

ENERGY

The move in oil prices in the second half of 2014 was probably one of the most important price actions for the commodity markets in years. Following a slight rise in the first part of the year, Brent prices then fell by about 48% — or $55 per barrel — until the third week of December. This was the most important decline in oil prices since 2008. The downward move was first triggered by a strong US dollar, elevated net long speculative positions at the end of June, and weaker fundamentals. Concerns about Iraqi and Libyan crude oil supply decreased despite the deterioration of the political situation in both countries while oil demand in Europe and in Asia weakened.

It was then the Saudi’s increase in crude oil production in September, an unusual move for this time of the year, which had a major impact on oil prices. Saudi Arabia decided to protect its market share at the expense of oil price stability. This contrasted significantly with the past 4 years when the Kingdom was balancing the oil market by itself. Other OPEC Gulf countries followed the Saudi steps, contrasting with Iran and Venezuela, which called for a lower production-target in order to stabilise oil prices as these countries require an elevated oil income to sustain their regime. This resulted in an unchanged OPEC production-target during the last Cartel’s meeting at the end of November.

This decision implied that non-OPEC producers or prices would need to adjust in order to balance an oversupplied oil market. It was oil prices which first adjusted to market conditions. However, Brent oil prices fell to around $60 per barrel, the lowest level since 2009, and an unsustainably low level. John Kemp from Reuters summed it up well last week as he wrote:  “If posted prices remain at current depressed levels [Brent at around $60 per barrel], almost all shale drilling activity will eventually cease, and U.S. oil production would start to fall rapidly towards the end of 2015 and into 2016 as output from existing wells starts to decline.”

Chart of the week: Performance of commodities and indices in 2014

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