The Hindu Business Line : Producers respond to low prices with output cuts

Grave concerns over continued global economic slowdown and reports that the world may already be in recession have resulted in heavy reductions in demand for a range of commodities. Supply response to rising inventory and falling prices is swift. Producers are rapidly cutting output, especially in energy and metals, perhaps the only way to respond in these crisis times.

Carbon steel and stainless steel production cuts have been notable. World carbon steel production is set to decline by 15-20 per cent year-on-year while stainless steel could be down y-on-y by as much as 30 per cent.

Interestingly, the downturn is taking place in every single region of the world, highlighting the global synchronised nature of the slowdown and has been devastating for the raw materials suppliers of the steel industry, commented an expert.

Governments too are responding to the ongoing financial turmoil.

The US Fed plan announcement of $800 billion in asset purchase has provided the markets with a modicum of hope.

A slight depreciation of the US dollar too has helped arrest further price declines. Chinese stimulus package ($585 billion) and lately, Eurozone package ($260 billion) as also, hopefully, one from India, albeit on a modest scale, may be contributory factors in future.

Gold has naturally benefited the most from the latest dollar weakness, but the other commodities to gain include cotton and zinc.

There are also incipient signs that investor sentiment in the commodity market may be shifting.

Last four months saw a certain pessimism with aggressive shorting resorted to by some investors.

This may now be changing. For instance, after several weeks of net short positions, net speculative positions in Nymex crude have moved to the long side.

Although growth concerns and, thereby, the demand side for most commodities continues to remain the focus of attention, and these concerns are not going to go away anytime soon, yet there will be a turning point in commodity markets at some stage in 2009.

When precisely it would occur is difficult to predict. Third quarter of 2009 looks promising by which time the cumulative effect of production cuts would also begin to bite. The first two quarters of the new year will hold some pain for the market.

Gold

Report of a sharp recovery in jewellery gold demand during the September quarter, reflecting partly the effect of a lower USD gold price, boosted the metal last week. Gold gained by about 10 per cent. Weakness in the US dollar too aided the price action. Indian physical demand for jewellery bounced higher during July-September buoyed by marriage and and relatively lower prices.

In London, on Friday, the PM Fix was $814.50 an ounce, little changed from the previous days $814.00/oz. Silver was at $10.12/oz (AM Fix) on Friday versus $ 10.26/oz the previous day.

It is clear, if the USD retains its recent weakness, gold prices should find a firmer base to build price gains from.

Less committed investors have exited the Comex positions, and in turn net fund length is hovering close to the lows of June 2007, pointed out an expert.

This suggests the downside risk from the current levels may be limited.

A weak dollar means higher gold prices in dollar terms. However, foreign exchange strategists are not sanguine about further weakness in the USD in the short-term.

The potential for the greenback to strengthen, rather than weaken, in the near term could cap golds upside potential.

Gold jewellery demand will be supportive of gold prices in the coming year.

However, such support would come at a lower price point than currently prevailing. For instance, there is bound to be resistance in India at current prices of around Rs 13,000 for 10 gm as the market is highly price sensitive. How soon and by how much the currently enervated rupee will recover vis-À-vis the dollar remains a point of debate. Slowdown in major Asian economies and consequent dent in purchasing power also need to be factored in.

Going forward, clearly, the outlook for the yellow metal is linked to prospective developments in the international financial system and movements in the US dollar.

Asset diversification and safe haven demand are sure to underpin prices. Inflation is of course not an issue any more because of weakened economic outlook.

According to technical analysts, in the short-term, the momentum is bearish.

The recent uptrend may be faltering as evidenced by the metal drifting sideways last two days. Because it has not breached 800, there is a higher bias for a push towards 845/850.

Base metals

This complex has borne the brunt of global economic slowdown.

Contraction in liquidity and sharp decline in demand and rising inventory have taken a toll on market prices. Contraction in construction and motor vehicles sectors have dented consumption. Most base metals have found themselves in surplus in 2008, and well into 2009.

There has been an aggressive short-selling in this complex. There have been short-selling rallies too, but these are unlikely to sustain given the overall gloomy outlook.

Producers, no doubt, are cutting output (especially zinc, nickel and aluminium); but the quantum of cuts is unlikely to arrest the downside risk. More cuts may be resorted to.

Copper is likely to witness range-bound trading around a declining trend over the next few weeks. Buying in the low $3,000s and selling in the high $3,000s is advisable. In case of nickel, there would be sideways trading as demand remains weak and stocks hefty. In aluminium there is potential for further price weakness.

Crude

Oil prices may be in the process of stabilising, trading in the mid-50s. In the short-term, demand conditions and flow of economic data are sure to pressure prices. OECD demand continues to be weak.

In the US, demand decline may be moderating as indicated by October data. Global demand growth is sure to remain subdued over the coming months.

However, supply side constraints continue to remain too. OPEC decision to cut production should allow prices to stabilise at the front end of the curve.

Whether or not there will be more cuts is a matter of conjecture at this point of time.

One should brace for higher front-end prices in about two quarters from now when output cuts would begin to bite.

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