Commentary. Cheaper crude oil to keep metals on leash

The steep fall in crude oil prices over the last three months has heightened the uncertainty surrounding global commodity markets, which are already buffeted by a host of factors. Rising supplies and weaker demand have combined to bring about a marked change in market fundamentals, and in turn, sentiments. Many metals are already subject to vagaries such as government policy (nickel), falling grade (copper) and mine depletion (zinc).

The metals market, comprising industrial, precious and base metals, looks particularly vulnerable to the fallout of lower oil prices. Even as crude has fallen below $50 a barrel, oil producers are not ready or willing to stem the price collapse. With incremental supplies expected to outpace incremental demand in the coming months, observers agree that low oil prices are here to stay for some time, at least over the next two to four quarters.

What will be the effect of low crude prices on the base metals market? In some sense, it will be positive for base metals, especially from the point of cost of production. By its nature, mining is energy intensive and some processes such as smelting too require high levels of energy consumption. Lower crude prices are sure to move cost curves lower. In addition to lower production costs, logistics (mainly transportation) costs will also drop. Aluminium is one such metal that is highly energy-intensive.

While lower energy costs will drag production costs, there may also be an increase in industrial consumption demand, especially the kind of demand that is price-sensitive. But such demand increases will happen with a time lag.

For the consumer, the lower crude price is widely seen as friendly. It will translate to a rise in real income, which will convert to additional demand. In the event, the market for consumer-focused metals will have to be watched. Platinum and palladium as well as aluminium and zinc will, in particular, draw attention.

On the other hand, construction or infrastructure related metals such as copper may receive less attention from market participants.

Lower crude prices have largely muted the inflation expectations. In the medium term, inflation expectations have been lowered across economies. It means more asset allocation may move away from commodities. Some commodities that are widely seen as a hedge against inflation — gold, for instance — may not benefit from lower oil prices.

Clearly, crude oil price dynamics are set to affect different commodities differently. How long the current low prices will last is anybody’s guess.

COMMENT NOW