After heating up for much of the year, commodity prices have gone off the boil. Oil, having more than doubled, has slid by almost 10% to a three-week low under $70 a barrel, helped along by a strengthening dollar as risk appetite has dwindled. The London Metal Exchange (LME) index of six metals has fallen by 10%, with copper – up 60% in eight months – now back below $5,000 a tonne.
Fundamentals bode ill
The rally in commodity prices has gone “too far, too soon”, says Craig James of CommSec. A key feature of the commodities run-up was investors’ hopes of an economic rebound, which they have now realised is unlikely to materialise soon. As far as oil is concerned, there has been scant evidence of an improving supply and demand picture.
Crude stockpiles in the US are at a 19-year high; oil cartel Opec’s current spare capacity is a whopping six million barrels a day. The fact that political tension in Iran and Nigeria has failed to bolster the market shows how well-supplied it is, says Tom Bentz of BNP Paribas. He also notes that speculators in the oil market are “heading towards the exit doors” now that the rally has gone beyond “anything warranted” by the fundamentals.
The metals markets also look vulnerable to further falls. Sentiment has been buoyed by record Chinese imports as the government has been stockpiling raw materials; in May, copper imports were 258% up on a year earlier. But this stockpiling can’t go on forever. With prices now higher than when stockpiling began, and the strong seasonal pattern in China’s base metals demand, Chinese import demand is likely to “subside significantly” in the second half, according to Barclays Capital. Imports look set to decline markedly in the summer, “hurting near-term sentiment”, agrees Standard Chartered.
In any case, underlying demand in China doesn’t look all that robust. Domestic supplies of copper were used up at a slower rate in May, says Miles Johnson in the FT, while Capital Economics points out that sales of construction equipment remain “very weak” and domestic steel prices are lower than at the start of the year.
No sign of Western demand
Meanwhile, there is no sign yet of Western demand increasing; Barclays Capital doesn’t expect a big rebound in OECD demand until the end of the year. That doesn’t leave the copper rally with much to go on. “The evidence is that Chinese and global growth aren’t strong enough to support the metal’s soaring price,” says Ian Campbell on Breakingviews.
It’s a similar story with aluminium. A recent increase in investor risk appetite has bolstered prices and deflected attention from the fundamentals. Inventories of the metal in LME warehouses are at record levels and five time last June’s figure. “It is very unlikely that we will see a large enough recovery in underlying demand to clear the supply, even if there are signs of increased appetite in China,” says David Wilson of Société Générale.
All in all, then, the “gravity-defying rally”, as Lena Komileve of Tullett Prebon puts it, looks set to cool further. Deutsche Bank has pencilled in an average aluminium price of $1,345 a tonne in the third quarter; it is currently above $1,600. Its third-quarter oil target also implies further downside, with the price expected to average $45.