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CIBC World Markets Inc.
Economic Insights—April 29, 2015
Commodities: Looking for the After-Party
Nick Exarhos and Andrew Grantham
The party’s over, and now we’re dealing with the
hangover. A flood of new supply driven by the prior
commodity cycle’s investment boom has hit the wall of
waning demand in emerging markets, particularly China.
And while lower supply will alleviate the pressure placed
on some prices (for example, oil), a slow global growth
environment going forward will ensure that any afterparty in commodity prices doesn’t live up to the hype of
2007 or even 2011.
countries at this stage were still seeing strong population
growth, whereas China’s is already slowing and due to
ease further going forward (Chart 1, right).
The result is that China’s 8% or so average growth in GDP
per capita since the global downturn was well above that
achieved in the US or France (both around 4.5%), and
even South Korea (6.5%), when those economies were
at the same stage of maturity. While recent stimulus
measures should help manage a “soft landing”, the
global economy needs to get used to a slower Chinese
growth pace over the coming decade.
Global Growth: Failing to Step on the Gas
Ever since the end of the recession, forecasters have
been waiting for global growth to accelerate. Yet it
hasn’t happened, and we remain stuck in the 3½%
or so range that we have been in since the early days
of the recovery (Table 1). The fallout from the financial
crisis meant that growth in many developed countries, in
particular Europe, was slow to recover. That has impacted
developing countries as well, with many still reliant on
Western consumers to buy their exports.
Commodities Still Have a Place in Portfolios
A lower speed limit on global growth is already restraining
prices for many commodities. But that doesn’t mean
investors should shy away from that space. The decline
in oil prices, for example, has been more a story of excess
supply than flailing demand. Meanwhile, a continued
recovery in the US housing market should see lumber
prices perform well over the coming years. Out of the
commodities we cover, oil and lumber are two of our
favourite picks for the coming year (Table 2). In addition
to greater potential upside in prices, they also provide
greater diversification for investors than, for example,
metals, which are often highly correlated with each other
and the broad commodity space (Chart 2).
While there are signs that 2015 will be a better year for
the Eurozone and the US, that’s largely because both are
among the highest net beneficiaries of lower oil prices.
Plenty of spare capacity remains in Europe, allowing it
to grow above its long-run “potential” in 2016 as well.
But that’s not the case stateside, where we see growth
easing to a 2.4% pace next year.
For China, somewhat slower growth should be expected
given its development stage. Looking historically at when
other countries were at a similar level of GDP per capita,
the 7% growth rate target Chinese authorities have set
for this year doesn’t appear all that elevated (Chart 1,
left). There’s one big difference, however. Most other
Chart 1
China Slightly Ahead in Growth Rates (L),
But Without Demographics to Back it Up (R)
10
Avg. Real GDP
Growth (% Yr/Yr)
8
3.6
US
2.2
2.4
2.9
2.4
EZ
-0.4
0.9
1.7
2.0
China
7.7
* at Purchasing Power Parity
7.4
6.8
6.6
US 1934-53
France 1950-69
Korea 1984-2003
China 2007-26 (F)
95
85
t+18
3.4
t+15
3.3
t+12
3.3
t+9
World*
105
0
Korea 1984-2003
2016F
France 1950-69
2015F
US 1934-53
2014E
China 2007-2014
2013A
t+6
2
t
Global Growth Not Joining the Party
115
t+3
4
Population Index
Start Year = 100
125
6
Table 1
135
Source: OECD, IMF, CIBC
3
CIBC World Markets Inc.
Economic Insights—April 29, 2015
Chart 3
Demand Effects Only Partly Responsible (L);
US Rig Efficiency Topping Out (R)
Drop in WTI Since Jun-14
0
US Rig Effeciency
(Weighted Average)
-20
0.3
0.0
2yr
5yr
10yr
-40
-0.8
-50
%
Est Demand
Effect
Nov-13
-0.5
-30
bbl/day
Actual
Decline
Feb-15
0.5
-0.3
300
290
280
270
260
250
240
230
220
210
200
-10
0.8
Nov-14
1.0
Aug-14
1.3
May-14
Correlation to Overall Commodity Complex
Feb-14
Chart 2
Source: Bloomberg, CIBC
Source: Bloomberg, EIA, CIBC
Oil Rout Driven Primarily by Supply
wells offline. With the average shale break-even placed
at around $70/bbl, rig counts in the US have halved from
year-ago levels.
The biggest story this year has been the dramatic
decline in oil. Though crude hasn’t been alone in feeling
the weight of slowing global demand, the principal
component that explains the demand side driving cyclical
commodities shows that the majority of oil’s decline has
been driven off specific supply effects (Chart 3, left). The
shale revolution has driven a near-twofold increase in US
oil production over the past five years, with America now
pumping over 9 mn bbl/day.
And though productivity gains, driven in part by
producers focusing on the highest yielding oil fields and
by technological advances in the hydraulic fracturing
process, have buffered the fall in absolute rig counts,
improvements on that front appear to have reached their
near-term limit. After seeing an upswing as prices initially
tumbled in late-summer 2014, average US rig efficiency
has flat-lined for the past few months (Chart 3, right).
That rapid increase wasn’t matched by a commensurate
rise in worldwide demand, which grew by slightly under
3.5% between 2011 and 2014. The dramatic fall in
prices, however, has meant that American producers have
had to slash investment plans and take more expensive
Crude Imbalance to Narrow by H2
US supply will tail off in the coming quarters, and the
International Energy Agency estimates that there should
be roughly 2 mn bbl/day more in oil demand by the
Table 2
Key Commodities Prices
27-Apr
Oil (WTI)
$/bbl
Natural Gas (Henry)
$/Mn Btu
2012
2013
2014
2015 (f)
2016 (f)
2017 (f)
57
94
98
93
57
68
75
2.48
2.75
3.73
4.35
2.95
3.50
3.75
Gold*
$/troy oz
1202
1675
1202
1184
1100
1200
1150
Silver*
$/troy oz
16.38
30.3
19.5
15.7
15.3
17.6
17.4
Iron Ore (62% Fe)
$/mt
59
129
136
97
59
63
62
C opper
$/lb
2.74
3.62
3.33
3.12
2.75
3.00
3.05
Aluminum
$/lb
0.84
0.92
0.84
0.85
0.84
0.89
0.91
Nickel
$/lb
5.98
7.97
6.82
7.68
7.95
8.26
9.20
Zinc
$/lb
1.02
0.89
0.87
0.98
1.05
1.11
1.11
Lumber**
$/'000 bd ft
255
287
345
338
285
335
350
Potash
$/tonne
305
459
379
297
310
315
315
* end of period,
Source: CIBC
**1st CME Futures
4
CIBC World Markets Inc.
Economic Insights—April 29, 2015
Chart 5
1.5
2500
0.5
2000
0.0
1500
1000
fcst
-1.0
Jan Feb Mar Apr May
Jan-15
5.5
5.0
4.5
4.0
3.5
3.0
2.5
2.0
YoY, %
2015
Average 2010-2014
May-14
Sep-13
-2
0
2
4
6
8
10
12
14
16
3000
1.0
$/mmbtu
US Prod Growth (Inv., L)
Henry Hub Price (R)
Source: IEA, CIBC
*Note: Assuming OPEC Supply agerages 30.3 mn bbl/d
Source: Bloomberg, EIA, CIBC
That’s occurring at the same time as Chinese demand,
particularly for steel, slows dramatically, dragging prices
meaningfully lower (Chart 6, right). Our iron ore forecast
matches our expectations for cooler Chinese demand.
fourth quarter of this year than there was in the first,
balancing the global crude market (Chart 4). That rise in
demand will be critical in seeing a sustained recovery in
prices, as production will only be idled until we see prices
ramp back up to producer break-evens. So there’s likely a
longer-term ceiling on prices at around $75/bbl—a level
that we forecast on average for 2017 following a slow
and uneven recovery this year and next.
Copper, and Other Metals, to Face Slower Days
Copper faces many of the same demand headwinds
plaguing iron, but does benefit from a more diverse
set of uses. Furthermore, copper production hasn’t
seen the same type of surge experienced by iron ore.
Ore grades in Chile—the country responsible for a third
of the world’s copper production—are on the decline,
and other potential higher quality mine locations are in
jurisdictions with greater country-specific risk.
Natural Gas Upside Capped by Shale Abundance
The shale revolution has gained infamy in crude markets,
but the horizontal drilling techniques applied to oil
extraction took root in the drilling of natural gas. Growth
in landlocked US natural gas production has kept a lid
on meaningful price appreciation, and recent outcomes
could have been worse had it not been for cold weather
saving the day for producers, bringing inventory levels
slightly below their five-year average (Chart 5, left).
Chart 6
Iron Ore Production Continues to Grow (L),
While Marginal Consumer Slows (R)
Global Iron Ore Production
3400
3200
3000
$/mt
160
140
16
120
12
100
8
2600
4
60
0
40
Feb-15
Aug-14
1800
Feb-14
2000
80
Feb-12
2200
The commodity super-cycle drove massive investments in
expanding iron ore production. With companies hoping
to capitalize on surging emerging market demand, global
production has been on a steady climb (Chart 6, left).
YoY, %
2800
2400
Iron Succumbs to Chinese Slowdown
Mt
20
Aug-13
That’s certainly been a fillip to prices, though over the
longer term, trading in natural gas has been at the mercy
of production, where double-digit annual gains haven’t
been abnormal (Chart 5, right). Continued strong
production trends are reasons we think upside remains
modest in Henry Hub prices, though a strong economy in
the US should provide a solid base of demand.
Feb-13
-0.5
Bcf
Jan-13
3500
mn bbl/d
May-12
US Natural Gas Storage Levels
World Oil Market: Supply* minus Demand
Aug-12
2.0
Sep-11
Oil Demand to Catch Up by Q3
Jan-11
Cold Winter Drives Reduction in Storage (L), But Price
of US North Am. Nat Gas Driven by Production (R)
Chart 4
Chinese Steel Prod (L)
Iron Ore Price 62% Fe
(R)
Source: Bloomberg, US Geological Survey, CIBC
5
CIBC World Markets Inc.
Economic Insights—April 29, 2015
Chart 7
Chart 8
Metals Driven by Global Industrial Production Output
Gold Gaining Greenback Sensitivity
120
%
Yr/Yr
%
Yr/Yr
80
40
Dec-14
0.0
25
20
15
-0.1
10
-0.2
5
0
-80
2000 2002 2004 2006 2008 2010 2012 2014
Feb-15
Mar-15
Apr-15
-0.3
0
-40
Jan-15
-5
-0.4
-10
-0.5
-15
-0.6
CRB Metals Index (L)
CPB World Production Volume (R)
-0.7
60-day Correlation: Dollar Index and Gold
Source: CPB, CRB, CIBC
Source: Bloomberg, CIBC
end to 2014 and start to 2015 (Chart 9, left). A bottom
has likely been signaled by a small increase in firsthalf contracted prices (Chart 9, right), though sluggish
demand from Brazil and the US will cap potash’s upside.
That should increase the cost of capital for mining projects
going forward, creating a more constrained supply picture
and seeing copper prices perform slightly better than iron
ore. However, neither are likely to reach prior-cycle price
peaks in the medium term, since cyclical metals still largely
respond to the global industrial production cycle (Chart
7). Though we aren’t bulls on metals in general, supply
restrictions, largely driven by the Indonesian export ban,
have us favouring a nickel price appreciation.
Lumber Prices Underpinned by US Housing
The housing market should be a primary beneficiary of
a healthier US economy, and a vastly improved labour
market more specifically. Improved job prospects among
younger demographics in the US should encourage those
stuck living with relatives to branch off on their own.
And while renting a condo and multiples construction
will remain a larger part of the market than in past years,
new single-family sales—the primary driver of American
lumber demand—have been on a clear uptrend. With
interest rate hikes likely coming at a slower pace than in
past cycles, the US housing upturn shouldn’t be disrupted
and as such we are bullish on lumber in the years ahead.
Yellen Hikes to Cap Precious Metal Gains
Despite whatever delays have been created by a lacklustre
Q1, Fed hikes should be coming sooner rather than later.
The US$ should be a prime beneficiary of that move off of
zero, allowing the greenback to gain against most other
major currencies, including that most ancient median of
exchange, gold. And judging from recent correlations,
gold has been gaining sensitivity to the greenback’s moves
(Chart 8). There’s scope for the dollar to give ground
further out, as policy elsewhere normalizes, but higher
interest rates increase the opportunity cost of holding
non-yielding assets like precious metals. That should limit
gold’s upside further out, while weighing only slightly less
on silver, given its more diverse set of industrial uses.
Chart 9
Heathier Chinese Potash Imports Continue in ‘15 (L),
a Reason to Believe in a Price Bottom (R)
China Monthly Imports (Mt)
1.0
H1 China
Contracted Potash Prices
500
0.8
Potash Prices Finding a Bottom
400
0.6
In fertilizer markets, there are some more encouraging
signs regarding Chinese demand. The economic rotation
toward the consumer has been a cause of poorer results
for cyclical commodities. But a more protein-intensive
diet amongst emerging market populations will be a
strong source of potash demand going forward. Though
the breaking of the producer cartel had smacked prices
in recent years, Chinese import shipments saw a strong
300
0.4
200
0.2
100
2013
2014
Nov
Sep
Jul
May
Mar
Jan
0.0
6
$/mt
0
2015
Source: Bloomberg, CIBC