Raw material prices have been “savaged by the most aggressive bear trend in commodity market history”, says Lawrence Eagles of JPMorgan. Before a bounce early this week as risk appetite partially returned, the CRB index, a global raw materials benchmark, had hit a five-year low. Oil has dipped below $50 a barrel for the first time in five years and is around 66% down from this summer’s record. Copper is still down by around 60% from its July peak of almost $9,000 a tonne. Platinum and palladium have fallen by almost two-thirds since their March highs, with the former now around $800 an ounce. Only gold has bucked the latest slides, hitting a four-week high above $800 an ounce as investors sought out a safe haven.
The market is set to remain under pressure, says Robin Bhar of Calyon. As the global recession deepens, “the demand slump for commodities can only continue”. And the global outlook is grim, with the IMF pencilling in the first simultaneous recession in America, Europe and Japan since 1945.
As far as oil is concerned, we are looking at demand destruction rivalling that caused by the oil shocks of the 1970s, says Antoine Halff of Newedge brokerage. According to the American Petroleum Institute, demand in America, the largest oil consumer, slid at its fastest rate since the early 1980s in the first ten months of the year. Moreover, history shows that Opec has trouble counteracting price falls with production cuts when demand slumps. Given the “putrid” economic outlook, don’t rule out $30 oil, says oil analyst Stephen Schork.
The slowdown in China, the world’s top user of iron ore, aluminium, zinc and copper, has intensified jitters over demand for raw materials. Morgan Stanley thinks growth may undershoot 7.5% next year, the slowest rate since 1990. Chinese demand for copper has fallen – imports dropped 14% year-on-year in the first ten months – and this will be only “partially moderated” by the stimulus package, says Lex in the FT. The other three big copper consumers, Germany, Japan and the States, are contracting. Copper inventories in warehouses registered with the London Metals Exchange are at a four-year high.
With supply set to grow next year even though producers have started to cut back output, and demand likely to shrink, further falls are on the cards. Catherine Virga of CPM expects copper to fall to $2,250 a tonne from around $3,400 now; zinc, around $1,200 a tonne, is heading below $1,000 and lead also has more downside.
As prices fall, producers are cutting supply, which will lay the foundation of the next commodities upswing once global demand recovers; there have been “sizeable volumes of production” already cut in zinc, nickel and aluminium, says Barclays Capital. But more cuts will be needed, given the scope for market surpluses to develop as demand deteriorates. Demand destruction remains the over-riding theme.
And it’s not just about fundamentals. Investors such as hedge and pension funds have been fleeing as they have had to raise cash for margin calls, intensifying the downdraft, says Patrick Barta in The Wall Street Journal. The oil market was particularly prone to speculative excess, with futures and options positions expanding almost fivefold over the past four years, outstripping by miles the underlying increase in physical demand for oil.
Moreover, now that traders have built up big short positions in oil and metals, there is scope for “violent” short-covering rallies as risk appetite returns, says Barclays Capital. Given the extent to which risk appetite is influencing commodities – platinum could range from $700-$1,400 over the next six months depending on this factor, say Johnson Matthey – the medium-term outlook for commodities appears both bearish and bumpy.