G. Chandrashekhar

Mumbai, Oct. 26 It was a disastrous week for the commodities market. There was an across-the-board collapse covering especially industrial metals, base metals, precious metals, ferroalloys, scrap and energy products.

Among commodity groups, it is noticeable that energy and industrial metals saw the steepest falls, followed by precious metals. Agriculture markets have declined less.

The collapse of the commodity market in tandem with the financial market reflect growing fears of a severe global recession. Currently, the markets concern is largely confined to the demand side with buyers adopting a wait-and-watch attitude. Withdrawal of credit facilities and uncertainty about future movements of the market has forced participants to turn extremely cautious.

While consuming industries are in the process of de-stocking (using up existing stocks), producers have begun to undertake production cuts. Price falls have been so massive that low-cost producers have no choice but to cut back output. It is not only that steel, nickel and zinc producers who have announced output cuts; on Friday, OPEC too decided to cut crude output by 1.5 million barrels a day beginning November.

It is as yet unclear how these developments will pan out over the coming weeks, even months. For the confidence to return to the market, money supply (US dollars) needs to improve. The greenback has become scarce resulting in value appreciation. With energy and metals prices falling, inflation concerns have receded into the background. All these have weighed on the markets.

Gold under pressure

Prices have come under pressure with worsening macroeconomic environment now shifting to emerging markets.

A strengthening dollar has pushed precious metals’ prices down. A slowdown in producer de-hedging is also anticipated. The gold market will be in small surplus in 2008 primarily due to the sharp decline in jewellery demand in the first half of the year, and limited prospects for a demand recovery, notwithstanding seasonal factors.

Investor interest is the key. Going forward, the huge fiscal deficit of the US should see the dollar weakening, which in turn would prove positive for gold. When would that happen is difficult to predict at this point of time.

One can expect volatile market conditions to continue to characterise the gold market, with a bias to the downside from the current levels.

The Indian market has not had the full benefit of overseas price falls because of a steadily depreciating rupee which makes imports so much more expensive. Currently, physical buying to feed the festival demand serves to prop the domestic market. But going forward, buying support at the household consumer level may wane.

On Friday, in the London spot market, the PM fix was $712.50 an ounce, down from $720.00/oz on Thursday. Silver was down by a whopping 4.9 per cent to $8.88/oz (AM Fix), from $9.34/oz the previous day.

Technical analysts asserted that both short and medium term outlook for gold is bearish.

The market could test 650/645 if there is a decisive close below 700. Ultimately, the risk is for a return to 550/575 in the medium term.

Base metals fall

Prices fell by 10-20 per cent last week.

The sentiment is clearly sombre with prices taking a heavy beating in recent weeks. The contrast with prices a month ago is stark to show the magnitude of value loss.

Towards end-September, copper was trading at $7,000 a tonne, and now it is $3,800/tonne, a massive $3,200/tonne fall.

During the same period, nickel dropped from $16,900/tonne to $9,800/tonne (decline of $7,100/tonne) and zinc is down from $1,785/tonne to $1,135/tonne (fall of $650/tonne).

With this kind of decline coupled with weak demand prospect, producers have no choice but to undertake output cuts.

Many metals are now trading well into the cash cost curve with aluminium, zinc, lead and nickel prices all now trading below marginal costs, observed an analyst adding copper prices are much closer to this level.

Should these price levels sustain for some length of time, expansion plans and new investments will be put on hold. But the overall negative sentiment and lack of demand may be so overpowering that a further fall in prices, albeit in the short term, cannot be ruled out.

Weaker demand means that most base metals will move into surplus in 2008. Aluminium could be at the bottom of the price fall and may start consolidating. Copper is near the marginal production cost. So, it may be advisable not to go short, but to sell into rallies. In nickel, there may no respite from low prices due weak stainless steel demand.

Crude price

On Friday, the OPEC announced 1.5 million barrels a day production cut on September production levels, effective from November. In the official press release, it was stated that the current OPEC-11 production ceiling of 28.808 million barrels a day would be decreased by 1.5 million barrels. OPEC may be open to additional cuts should the station warrant.

The market reaction was muted. The decision did not materially affect prices. In the US, crude oil stocks are drifting higher. Consumption demand in industrialised countries (OECD) continues to be weak with limited prospect for a recovery.

Further pressure on prices is possible until financial market stabilises. Eventually, the supply side dynamics may help push prices higher over the coming months. But, in the short-term potential remains for further downside.

Related Stories:
No fear of commodity bubble: Barclays

(This article was published in the Business Line print edition dated October 27, 2008)
XThese are links to The Hindu Business Line suggested by Outbrain, which may or may not be relevant to the other content on this page. You can read Outbrain's privacy and cookie policy here.