Trends in selected commodity markets
Commodity prices declined 14.1% in December following a decline of 16.8% in the previous month. As in the two previous months, the December drop in the IMF commodity price index was one of the largest since the publication of the index in 1992. The deeper deterioration in the financial and economic conditions continues being the determining factor behind the dramatic decline and volatility of commodity prices via the negative impact on demand. Considering the dramatic fall of major economic indicators for the US and other OECD regions in the last quarter of 2008, it becomes clear that there is no possibility that the rest of the world could offset the expected sharp deceleration in demand. There are also signs of deceleration in non-OECD in major emerging countries such as China, India and Brazil.
The same combinations of negative factors since the collapse of commodity prices last October persist, namely the weakening in global demand and credit constraints. A recovery of commodity prices in the near term is unlikely considering the disastrous macroeconomic panorama; a sustainable recovery in commodity prices would only be possible once the global economic recession will begin to recede possibly in the second half of 2009. Although prices have plummeted along the commodity spectrum, energy and especially crude oil and metals have been the major losers as they are strongly correlated to the economic cycle. Agricultural products haveperformed better in relative terms, since these products are more isolated from the GDP cycles.
The trend in the IMF commodity prices index in December is explained by the plunge in energy and especially crude oil and metal prices. During the first week of January, an unexpected recovery due to temporary factors was seen in the commodity markets. There seems to be agreement among analysts on a negative outlook for commodities over the short-term with a potential slight recovery only coming in the second half of 2009.
The energy commodity index (crude oil, natural gas and coal) posted the worst performance within the commodity spectrum for the third month in a row. Crude oil prices (the averaged petroleum spot price) have fallen dramatically by 23.2% m-o-m (around 40% lower than a year early) in December and despite the rise in geopolitical tension no visible and sustainable recovery is foreseen.
Henry Hub gas sank by 12.9% in December. This was a reverse in the relative recovery experienced last November ascribed to temporary factors. High production and economic turmoil exerted pressures on natural gas through lower demand. US gas consumption is expected to have slackened in December as a result of shrinkage in industrial and electricity-generation demand which together with output growth due to production increase as seen in the prolific Barnett Shale field in Texas, weighed on US natural gas prices suggesting an unfavorable outlook for 2009. It must be noted that economic recession is exerting pressures on natural gas through competition with low crude prices as well. Ample storage also added to the bearish trend.
The outlook for this natural gas thus remains bearish due to forecasted lower consumption in 2009 as a result of the economic recession.
Coal prices fell 14.7% in December on the same factors that weighed on prices in the previous months, namely lackluster global demand as well as a lack of liquidity, which hampered business.
Non-energy commodities plunged 6.8 % in December m-o-m, down 24.2% from year-ago level.
The industrial metal price index saw a fall of 10.9% m-o-m in December for the 8th consecutive month, a 36.4% yearly drop. Although some factors encouraged metal prices during the end of December, e.g. anticipation of index rebalancing and re-weightings, supposed to revive net buying of bases metals and of COMEX copper, LME nickel and LME zinc, and expectations of fiscal stimuli; However, the impact has proved to be short-lived. At present, the metal markets are characterized by massive surpluses reflected in very high inventories.
The metal complex together with the energy market has been severely hit by the economicand financial turmoil because they are the sectors most closely-linked to the economic cycle. The current economic recession translated into a plunge in production and weaker demand for raw materials emerging from construction, transport and other sectors. As in last November, the high level of inventories and the move of the forward curve into contango reflected weaker metal fundamentals. In this context, weak demand will remain the major factor behind metal markets without perspective of an improvement in the short term as there has been a worsening of recent indicators showing as decline in industrial production, European confidence and the US unemployment report. Analysts agree on the fact that even with production cuts, industrial metal prices will decline in the short-term owing the high surpluses.
Following the dramatic 22% drop in copper prices in November, prices fell a further 16.7% in December. Still copper was a loss leader in December with the falling trend in the three final months being the worse since 1980. The three-month forward curve moved into contango at the end of October. The milder decline in copper price in December was related to high Chinese imports which led global copper demand to remain artificially high. Chinese buyers were piling up stocks encouraged by declining prices at the LME, which helped to support prices. Despite that, the accumulation of stocks at the LME in December indicated that global copper demand is weak. On the positive side, the Chinese government has announced plans to buy metal from local smelters and production adjustments are still in progress. The magnitude of the current economic recession makes a recovery in copper price in the short-term unlikely.
Aluminum prices sank 19% in December, which compared unfavorably with -12% in November -37% lower down from the year ago level as a result of slow of demand from the construction and transport sectors. The critical situation of the US automotive sector seems to have been a key factor with major US automakers reporting a large fall in car sales in November, at up to 47% for Chrysler. On top of that, construction spending in the first 10 months of 2008 dropped 5.7% y-o-y. Despite efforts of producers to reduce output significantly and the approval of a rescue plan to the automotive sector in the US, a recovery in of aluminum prices in 2009 is not foreseen given the magnitude of the surpluses and the severity of the economic crisis. Likewise, if production cuts materialize, there are still some new capacities coming onstream. The latest data flowing from China has not been encouraging, with reports that aluminum production remained the same on a yearly basis (8.2%), which represents bad news as China is the world’s largest producer country.
Nickel prices kept slumping by 8.6% m-o-m, down 62.2% from a year earlier. The same negative factors that have exerted downward pressures on this market are still at work: deteriorating demand from the stainless steel sector, which has seen on weakening demand from end-users. Chinese major producers cut production in October by 50% as a result of tumbling demand and despite nickel inventories at the LME continuing to increase in December. The outlook for nickel market remains gloomy despite the cut in production in nickel mines which is estimated to reach 16% of the expected output for 2009 due to unfavorable conditions in the stainless steal market and in the transport and construction sector at the global economy.
Zinc prices reported a 4.8% drop in December which compared favorably to a 10% loss in November. However, prices are still 53% lower than a year ago due to a series of sharp production cut announcements. However, as in other industrial metals, the key factor behind this market was weakening demand due to the collapse of the automotive and construction sectors and zinc LME inventories posted high gains in the first part of December. The construction sector whose demand fell 5.7% during the first 10 months of 2008, accounts for 45% of global zinc demand. Despite the recent decision by the US government to provide US$13.4 bn to Chrysler and GM, a recovery of the zinc market in the short-term is unlikely.
The World Bank’s agricultural price index continued decreasing in December by 4.0%, compared to 5.7% in the previous month. The mild improvement was ascribed to a recovery in cocoa prices as a result of a significant slow-down in shipments to the port of Abidjan, Ivory Coast. Also, palm kernel oil prices increased on higher imports from China and Europe. However an important decline in raw materials took place as well, notably in rubber, owing to lower oil prices and weak demand for vehicles. In general, similar factors as in the previous month have affected agricultural prices — weakening demand, sharp drop in crude oil prices, investor risk aversion and an improved supply outlook. The decline in the IMF food price index eased from 5.5% in November to 2.7% m-o-m in December on the relatively better performance of corn, wheat and soybeans. According to some analysts, agricultural products can perform as a “defensive commodities” — cereals and lower-cost proteins — because they may be less affected by lower income growth. Indeed the agricultural sector has performed better than the energy and industrial metals, because losses in demand have not less dramatic and are supposed to remain so because of the role of population growth in agricultural demand. Thus the outlook for agriculture in the near term is better than for the rest of the commodity sector.
Following a decline of 5.7% in November, gold prices reported a 7.3% m-o-m positive growth rate in December influenced essentially by investor safe haven buying in the face of the tremendous economic and financial crisis, although physical demand is still weak. As shown below, a strong recovery of global inflows into gold ETPs was reported in December. In the near term, gold prices may fall due to a deflation and the movement in dollar, depending on whether there is enough investment demand. In the forthcoming months, the outlook for gold look quite positive considering the following encouraging factors: first, a likely weakening of the US dollar against the euro on a 12 month basis; secondly, a recovery in crude oil prices towards the middle of the year and, thirdly, an inflationary scenario by the end the year.
Investment flow into commodities
According to CFTC data, open interest volume declined further by 310,000 contracts to 5,660,000 m o-m in major US commodity markets in December, with compared to a decline of 277,000 contracts in last November. This was according to the commodity price decline in November and the severity of the global economic recession. A mild increase of 27,000 contracts in net longs non-commercials due to a higher decline in short than in longs. Consequently, the net noncommercials as a percentage of OIV for the US commodity markets slightly increased sin November from 1.9% to 2.5% in December.
Agriculture open interest dropped 261,000 to 2,923,000 contracts in December m-o-m (99,000 contracts more than in November), being the determinant factor behind the decline in total open interest. Both long and short non-commercials dropped to 567,000 and 428,000 contracts respectively. Thus the net length of non-commercials as percentage of OIV fell from 6.0% to 5%. Soybean oil and corn experienced the worst performance within the agricultural complex in terms of investment activity.
Precious metals open interest declined by 18,000 to 406,000 contracts in December m-o-m, which compared favorably with the 36,000 contracts decline in November. Non-commercial longs in this commodity group climbed by 11,000 contracts m-o-m in December, which combined with the 24,000 decline in short contracts led to an increase in net length as a percentage of open interest volume from 24.1% to 33.6%.
Natural gas (Nymex) open interest fell 43,000 contracts to 701,000 contracts in December m-o-m
compared to a 98,000 contracts drop in November. Non-commercial longs declined 9,000 contracts in December while shorts fell 14,000 contracts. Thus, the net-length as percentage of the OIV continued at a high level of
minus 22.1%.
The significant fall in copper prices in December led to a 5,000 decline in open interest to 72,000 contracts.
An increase in non-commercial shorts outpaced the increase in longs resulting in non-commercial net positions turning negative and the percentage of the OIV declined to minus 25.5.
The recovery seen in the inflows into commodity-linked ETPs in November continued at a faster pace in December with the inflows reaching $4bn. It should be noted that despite declining oil prices, it was energy and especially crude oil that was the largest beneficiary with $2.8bn in December. This was the largest ever inflow reported to any commodity ETP subsector.
Our estimates of the investment inflow into commodities suggest that the recovery reported in November continued during December. Investment into the two major commodity investment indices (S&P GSCI and DJCI) increased above 6% on 30 December from 2 December. The sector most favored were gold followed by crude oil.
The most favored sector was precious metals and especially gold. Despite declining prices crude oil benefited as well from the investment interest which may be partly explained by the fact that the formulas embedded in the indices implies that fund managers buy more futures when crude prices drop, which in turn, reinforce the contango in crude by encouraging inventory accumulation. In this sense, the increase in investment into the S&P GSCI or Dow Jones-AIG indexes may have contributed to the massive increase in crude inventories and therefore to the collapse in prices.
