What Does the Year Ahead Hold for Metals and Energy?

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Commodity prices, whether energy or metals, are being buffeted by a variety of factors.

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Investor sentiment (call it herd instinct) is a big one, but so are market fundamentals, particularly supply and demand trends. A third is macroeconomic and political developments which we have had more than our fair share over the last few years. We can guarantee that you will see current trends develop further and new ones unfold in the year ahead.

The Saudi-Iranian Political Conflict

Witness Saudi Arabia’s execution of umpteen “terrorists” (fast becoming a modern day euphemism for any undesirable) this week, including — crucially — a leading Shiite cleric Sheikh Nimr al-Nimr, causing outrage in neighboring Iran and igniting riots across the region from Turkey to India. The tension this caused the price of oil to spike 2% on Monday, although the long-term impact is likely to be limited, relations between Iran and Saudi Arabia couldn’t have been much worse before the incident and so haven’t much further to fall, short of outright war.

Crude Oil Hits lowest level since 2009.

Crude Oil Hits lowest level since 2009. Source: @StockCharts.com.

The point I am making is macroeconomic and macro-political developments impact the base metals and energy markets in ways distinct from supply and demand fundamentals. So what can we expect for 2016? First, it is election year. November will see a new President and while we all have our personal hopes and dreams, as an outsider I can say dispassionately I suspect it will probably be Hilary Clinton and a Democratic Senate. Politically, though, it will be a bumpy year in the US with much of the media and popular focus turned inwards rather than to global developments.

Major Changes Coming in Japan

On the other side of the world, Prime Minister Shinzo Abe’s three arrows have failed to lift the Japanese economy and the country fell back into recession late last year. However, while we have heard plenty of rhetoric over the last three years there does seem to be the suggestion that structural change is finally on the way and he may finally be getting serious about stimulating corporate Japan into investing at home and freeing up labor markets. 2016 could be the year Japan Inc. finally picks up.

One reason why inflation is so persistently low, globally, is falling commodity prices, not least of which is oil and it’s linked sister, natural gas. Benchmark oil and natural gas prices have collapsed last year, down a third and by two thirds since the fall started in 2014. Oversupply is unlikely to go away this year unless Saudi Arabia has a major change of heart, or collapse of confidence, as supply is set to increase with the arrival of Iranian oil. Demand continues to slow. It should be said, however, that oil consumption is not falling in top consumer China, it is still growing at some 2.5% in spite of recent attempts by Beijing to slow growth by suspending gasoline subsidies.

Low Gas Prices, Strong Demand

Reuters wrote recently that global gasoline demand has been strong, thanks to rising car sales. China’s November car sales jumped 20% from a year earlier the paper said last month, putting the world’s biggest automobile market on track for annual sales growth of 5-7%. Almost 25 million new cars are said to have hit China’s roads in 2015, and by 2020 most analysts expect annual sales of 50 million.

On the supply side, shale producers in the US, whose demise admittedly has been greatly anticipated but not seen to any significant degree, can’t — at $40 per barrel  — hold out much longer and 2016 will see a drop in production. Open interest on the futures markets suggests most investors are anticipating prices of between $50 and 80/barrel later this year with some analysts talking of over $100. We can’t see that in the current circumstances but we do see more upside than down by H2 2016.

What This Means for Metal Buyers

Prices for industrial metals have plummeted this year. Copper and zinc are down a quarter and nickel 40%. A rising US dollar will keep pressure on base metals as will continuing weak manufacturing data coming out of China. The groundwork is being laid for higher metals prices later in the decade as investment is being slashed and both mining and refining capacity mothballed, but most would expect these medium term trends to remain muted in 2016 and it could be 2017 to 2018 before they force a tightening of the supply market.

There appears to be no probability of a return to the dynamics that drove the super cycle of the last decade. Prices will rise due to tightening supply, not rising demand, and with global growth muted that’s unlikely to be during this year.

Indeed, one development that could postpone a rise is further devaluation of the renminbi. The Bank of China is likely to be reducing push through further interest rate cuts this year as the economy slows, while the Federal Reserve will be tightening. Much as Beijing would like a stable link the reality is further weakening towards 7Rmb to the dollar is likely during 2016 making Chinese base metal exporters more competitive on the world market and encouraging greater exports.

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It will be interesting to see the extent to which Beijing balances it’s twin priorities of environmental progress – reducing pollution by shutting unnecessary production capacity and removing incentives for cars – with it’s priority to maintain growth and employment. Last year saw considerably progress on environmental issues, this year that trend may slow if growth becomes more of an issue.

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