February 11, 2013

A global "currency war" will benefit commodities more than equities
Commentary by Senior Market Strategist Robert Balan

Looser monetary policy by the major economies has positive and negative implications for the rest of the world. Positive because it should strengthen demand in these important trading partners and tends to stabilize markets, but negative because some of the money does move to the rest of the world. It tends to strengthen already overvalued exchange rates, put underlying support for riskier assets, and can be destabilizing: fast money in can quickly become fast money out. It has led to concerns about retaliatory action from other central banks and the escalation of “currency wars”.

It is worth thinking about what more serious currency wars might look like. The normal comparison is made with the situation in the 1930s when a number of currencies left the gold standard in a series of discrete devaluations. But though that was destabilizing, the bigger problem was a drift into widespread protectionism. That reduced the benefits of comparative advantage at a time of already-great economic weakness, and both added to, and was a function of, extreme political dysfunction in many countries.

However, today’s “currency war” will probably take another form. It would likely take the form of monetary policy being loosened more than would otherwise be the case – in effect the monetary policy decisions made for example, in Washington and Frankfurt would lead to changes in monetary conditions in Brazil, Turkey and so on. Economies would loosen policy in a way that might make sense for their own economy but would lead to too much liquidity at a global level. Eventually, this could lead to excessive inflation in the longer run, with all central banks pointing to imported inflation as the culprit, ignoring the fact that at a worldwide level that cannot be the case. In the shorter term, the liquidity is more likely to boost asset prices sharply. Equities and commodities would be natural beneficiaries. The rally could go further whether or not central banks do the collective “right thing”.

The positive impact of global monetary loosening as a consequence of a currency war will push up all risk asset prices, but the price benefit will be uneven. At the outset, both equities and commodities will likely benefit on equal terms, but then commodity prices should accelerates, and once again outperform equities driven by growing inflationary anticipation.

Commodities and Economic Highlights
Commentary by Robert Balan, Alessandro Gelli, Marion Megel and Alban De Rougé

Germany strong factory orders adds aggregate demand for hard commodities

Germany's headline factory orders rose 0.8% m/m in December, broadly in line with consensus expectations (0.7%). This brought the Q4 2012 orders average to about 1% q/q above the Q3 2012 level, the strongest showing since Q2 2011. Core orders that exclude volatile large transportation equipment orders rose for a third consecutive month (+0.6% m/m in December) but their Q4 2012 average still remains slightly (0.2%) below the Q3 level. Foreign orders saw a sharp rebound in demand from other euro area member states that jumped 6.8% in December (core orders: +4.3% m/ m), driven by a surge in investment goods orders (up 11.3%).

All in all, German factory orders move back on to a positive trend in Q4 2012, which should continue in 2013, as indicated by new order components in the PMI and IFO surveys. This bodes well for forecasts of a swift recovery of economic activity currently underway in Germany, also reflecting a robust expansion again of industrial activity. Stronger industrial activity will add to the aggregate demand for hard commodities and energy.

Seasonally inflated data still confirms a robust economic recovery in China

January Chinese export and import growth surged to 25% y/y and 28.8% y/y respectively, stronger than consensus expectations (17.5%, and 23.5%). Besides the well-documented holiday distortions, possibly higher y/y export and import prices, and stronger demand could have contributed to the outcome. While caution is certainly warranted and a better reading of trends will need to wait until after the February releases, the prints suggest that risks to the market's 8% export growth and 7.9% GDP growth forecasts for 2013 are tilted to the upside. The trade numbers are inherently strong.

Furthermore, January saw the expected easing in y/y CPI inflation and PPI deflation, to 2% and -1.6% respectively, from 2.5% and -1.9% in December. Holiday effects pushed up m/m CPI to 1% (to be expected), with meat and vegetable prices contributing 60% of the increase. The m/m PPI rate also rose by 0.2% on rising commodity prices. The different timing of the Chinese New Year (10 February vs 23 January last year) would lead to a slowdown in y/y inflation in January, followed by a jump in February. Beyond the monthly volatility, the market expects CPI inflation to rise gradually, reaching 3% in Q3 and 4% in Q4.

While the outlook for Chinese oil demand remains positive, the very strong Q4 2012 showing may have been inflated by seasonal and one-off factors. Seasonal stock building, the concentration of new refining capacity additions to Q4 2012 and an unusually cold winter likely helped push up refinery runs. Real demand was softer, evidenced by soft crack prices and increased product exports, counter to seasonal trends. As industrial activities are likely to stay muted in Q1 2013, real oil demand may hit a soft patch before picking up again in Q2 2013. Oil demand recovered along with industrial activities growth, most accurately reflected in power generation. HSBC-Markit PMI has risen from 47.60 in August 2012 to 52.30 in January, confirming that manufacturing has been expanding and driving a recovery that is about to go more robust.

Nickel has still a long way to go to catch up with other base metals’ performances

Nickel has been the best performer since the start of the year, up by 9%, and has even outperformed US equities, despite the grim supply/demand picture. It appears that nickel, which was the worst performer on the LME last year, is catching up with its peer metals. Its prices remain indeed depressed despite the recent rally, still 36% below the highs of 2011 (was 40% two weeks ago), which is far more than the other base metals, which stand only between 15% (lead) and 25% (aluminium) below 2011 levels. 

Another supporting factor for the metal used in the making of stainless steel, has been the steady recovery of the Chinese inox market. Although production remain far below year-ago levels, it has slowly improved over the past months to hit in December 2012 its highest level since the previous summer. Moreover, as stainless steel makers are expecting higher orders and production in the coming months, they have started to rebuild nickel inventories, supporting prices. 

However, risks persist considering the high supply surplus expected this year due to numerous projects that should reach full production this year. In addition, nickel’s substitute, the cheaper Chinese nickel pig iron, should see its production growing strongly this year as producers are expanding capacity and could therefore be favored over refined nickel by stainless steel consumers. Despite this gloomy supply/demand picture, further strong performances are expected in the nickel market as the metal has still a long way to go to catch up with the general LME performance.

The soybean harvest is still at risk in South America

Since several weeks, hot and dry weather are hitting Argentina, leading analysts to cut their estimates for the country's soybean harvest. Forecast for the soybean harvest in Argentina, the third-ranked grower and exporter of the oilseed, has been cut by 1 million tonnes to 52 million tonnes. And this downgrade may not be the last. If the dryness continues until early February, soybeans and other summer crops will be stressed and the yield potential reduced. The weather conditions in Argentina in coming weeks will determine whether the current risk premium on prices must be raised further or whether we will experience seasonal supply and price pressure with fund liquidation.

Moreover, the deterioration in South America's weather is beginning to raise doubts of Brazil's too, dashing expectations of bumper yields. The wet weather in central Brazil, including in Mato Grosso, has until to now been seen as an impediment to harvest progress and logistics, but a support to yields. Indeed, upgrades to estimates for Brazil's 202-13 soybean crop have to some extent balanced downgrades to thinking on Argentina's, which is being sapped by hot and dry weather.

Chart of the week: Chinese oil demand is back

The slowdown of the Chinese economic activity in 2012 contributed to a weak oil demand growth. Indeed, oil consumption rose by only 350’000 b/d y/y to 9.6 million b/d. This was significantly lower than the past two years. In 2011 and 2010, Chinese oil demand grew by respectively 500’000 b/d y/y and 1’000 b/d y/y. Nonetheless, the rebound in the Chinese economy as suggested by the latest economic numbers, has coincided with the acceleration of oil demand during the Q4 2012. Latest HSBC Markit PMI for the manufacturing sector in China jumped to 52.30 in January 2013, the highest level since February 2011, suggesting a more rapid acceleration of Chinese oil demand growth. Chinese GDP should grow by 8.4% this year, up from 7.8% last year. Chinese oil consumption is hence expected to increase by 500’000 b/d y/y. This will more than offset the decline in OECD demand estimated at around 300’000 b/d. Nonetheless, the International Energy Agency, which has revised higher Chinese oil demand growth these past two months, continues to underestimate the strength of the Chinese economic growth as it forecasts Chinese oil demand to increase by only 390’000 b/d y/y in 2013, almost at a similar pace than 2012. Like in 2011, the Agency is likely to gradually revise upward oil demand growth and particularly Chinese oil demand growth on the ground of improved economic activity.

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