After five grinding years of losses, commodities are set to end higher in 2016 and investors are staking out increasingly bold calls for the coming year.
This reflects signs that the prolonged decline in markets such as oil and metals is finally having an effect. Cuts in capital spending by producers have begun to choke off supplies as global demand creeps higher.
It might not be a replay of the powerful “supercycle” of the early 2000s, when economic growth led by China put a strain on natural resources, but for the first time in a long time, commodities are out of trouble.
“The supply and demand scenario is tightening, and therefore prices have to go higher to increase supply. That’s the theme for 2017,” says Paul Kim of Aventis Asset Management, a Chicago-based commodities hedge fund.
The Bloomberg Commodity index (BCOM), a basket of 22 futures contracts, has risen nearly 10 per cent in 2016, on pace for its first annual rise since 2010.
The performance has varied widely among BCOM members, with zinc up more than 60 per cent this year, diesel fuel up about 45 per cent and wheat suffering a 12 per cent fall.
Wall Street turning bullish
Some Wall Street houses have turned bullish. Goldman Sachs last month advised clients to buy the GSCI commodity index, eliding memories of oil shocks and food crises to argue that “high commodity prices can be good for the world”.
Citigroup was once known to lean bearishly on commodities, but no longer. “There is absolutely no doubt that markets are at a turning point,” Ed Morse, Citi’s head of commodities research, says in a video presenting an annual commodities outlook. “We believe that momentum is going to carry through and generate even greater returns for investors in the year ahead.” A portion of banks’ revenue comes from selling commodity derivatives to investors.
Despite instances of low prices spurring consumption — for example, from US drivers burning more cheap petrol — supply will be a critical factor behind any further rally in commodities price.
What shook markets in 2016
Oil set to dominate commodities
In oil, the most widely traded commodity, the Opec cartel has agreed to curtail supply in the first half of next year after it tired of letting prices ration output. If Opec members and co-operating countries such as Russia succeed, they could finally draw down tanks brimming with excess crude.
“The big story for 2017 will be the extent to which Opec cuts force the inventory rebalancing of the oil market,” says Thomas Stenvoll, portfolio manager at Bocage Capital, a commodities hedge fund in San Francisco. “It will be a huge theme for the first half of the year.”
Another supply factor critical to both oil and natural gas markets is the how quickly US shale energy companies resume drilling as prices rise. Their response could undermine Opec’s new discipline and pressure oil prices again.
Zinc’s rally dependent on supply
Supply will dictate the fate of zinc, the best-performing metal of 2016. Its rally this year has been driven by a tight zinc concentrate market after miner Glencore cut production by two-thirds in 2015.
But with Glencore’s shares having nearly risen 200 per cent this year, and zinc prices now at $2,637 a tonne on the London Metal Exchange, the company could choose to put some of that production back into the market next year.
Industrial metals such as zinc and copper have climbed this year on hopes that stronger global growth and greater fiscal stimulus would underpin demand. US president-elect Donald Trump’s early comments in favour of infrastructure spending have added to the sentiment.
Gold to suffer from base metal demand
Gold has slid sharply from its peak of $1,366 an ounce in July as rising US interest rates increase the opportunity cost of holding an asset that yields nothing.
“We knew whoever won the US election would embark upon a fiscal stimulus plan, and I’m also of the view there will be fiscal stimulus across Europe as well as a number of Asian countries,” David Donora, head of commodities at Columbia Threadneedle, says. “That will increase demand for base metals rather than something like gold.”
Coal gains fade as new year looms
Surging coal prices were among the biggest surprises in commodity markets this year. After China introduced production curbs in April the fuel more than doubled, reaching $110 a tonne as utility companies were forced to import material. But the gains have already started to fade as policymakers in Beijing — alarmed by the spike in price — have relaxed the controls.
Grains surplus bodes poorly for 2017
Agricultural markets have been the weakest commodities this year, dragged down by grains and livestock. With silos carrying a surplus left over from several bumper harvests, the market will take direction from the weather in exporting countries such as Brazil, Russia and the US.
“We are in situation where stocks are very high worldwide, so they should cap any serious rally attempts in this market,” says Rodolphe Roche, head of commodities research at Schroders, the UK-based fund manager.
Additional reporting by Neil Hume