Commodities have bounced back since the start of the year, with copper up 60 per cent, zinc up 30 per cent and even aluminium, the laggard, up 18 per cent. The Reuters/Jeffries CRB index, which measures a basket of commodities, rose 13.8 per cent in May, its strongest rally since 1974. Most fund managers are generally positive on the sector’s outlook for 2009, believing the asset class could increase by 20 per cent or more this year, but with high volatility.
Long-term, the big structural drivers in commodity prices we have heard so much about in recent years still hold good. Supply will continue to be constrained as the mining industry deals with geological and political challenges, while the development of emerging economies with western tastes and other demographic changes will create unprecedented demand.
China encouraging
In the immediate future, however, further recovery in the commodities market will depend on a resumption in growth in both China and the western world, running concurrently as in
2004-5. But while the news coming out of Asia is encouraging, the pick up in the US is slow.
First China. Here, there are grounds for optimism. In just a decade, the People’s Republic has moved from accounting for 2 per cent of global demand to 20-45 per cent, depending on who you believe. In 2007, emerging markets equalled the demand of developed markets, but given their relative resilience during 2009 they now probably account for a larger share.
To demonstrate China’s scale, the annual growth in its demand for copper is equivalent to the absolute amount consumed by India. Encouragingly, therefore, its recent record iron ore, copper and coal imports have done a great deal to compensate for the slowdown in the western world.
Catherine Raw, a member of BlackRock’s natural resources equity team, points out that the Baltic Dry Freight index, a measure of the price of bulk shipping and an indicator of the trade in commodities from Brazil to China, fell over 90 per cent from a peak in May last year to September, revealing the severity of the situation when the mining world went from operating at maximum capacity to suddenly drying up. But the Dry Freight index is now up nearly 450 per cent from its low, indicating that trade has returned, albeit from a low base.
“China is a command economy and the fiscal stimulus is consequently already trickling down to the real economy in a way not seen in the US,” says Ms Raw.
She adds that 4600bn renminbi in Government-driven lending in the first quarter is a huge expansion in lending. “Chinese GDP growth for the first quarter is up 6.1 per cent from a year ago. That’s instead of around 10 per cent last year but it’s a stronger number than it appears. Goldman Sachs recently upgraded growth in China this year to 8.3 per cent, up from its earlier projection of 6.0 per cent.
“The decoupling theory is still there. The question is, is this a restocking event or a fundamental return to growth? The next three months will be critical,” she explains.
The drivers of the economy in China are very different, Ms Raw believes. “The Government needs to keep its people in business, and policies are changing. Rural land reform, for example, should give farmers more rights over their land, enabling them to borrow from banks using their land as collateral, increasing spending and boosting growth over the next decade.”
A cloudy view
Visibility on the US economy is murky. In recent months this has created a shift towards agriculturals, seen as the sector that is least impacted by the economic situation.
“We favour agriculture and specifically corn and soybeans during the second half of this year,” says Manfred Schraepler, head of fund structuring at Deutsche Bank.
“This reflects strong Chinese demand in the case of soybeans and a decline in corn acreage in the US. We expect the gains in crude oil and copper will be unsustainable into the second half of the year, based on our view that the US will not post positive growth until January 2010, the S&P500 will stage another downleg and GDP growth in China will slow markedly into the fourth quarter of the year. In addition we view the rally in many commodity prices during Q2 as more flow driven than reflective of underlying demand,” he explains.
Inventories have been kept under greater control than in previous downturns, with mines slashing high cost operations and reducing capacity, which has cut coking coal production by 13 per cent, nickel by 22 per cent, chrome by 65 per cent and platinum by 12 per cent.
