Key themes to track this year

Global commodity markets have entered 2012 in an uncertain macro situation, with several imponderables weighing on the minds of market participants. A significant part of the uncertainty is simply the baggage from last year and there is little clarity about what lies ahead.

In addition to the developments on the geopolitical front, the European sovereign debt crisis, unmistakable signs of slowdown in most major economies, especially OECD members, uncertainties relating to the trajectory of growth in China — the mover and shaker of world commodity markets — and not the least the currency market dynamics and contrasting monetary policies of countries, have created pessimism.

The market sentiment stands weakened. Signs of the tide turning in favour of growth and commodity consumption are weak at present. Because the outlook at the moment is hazy and any forecast can at best be conjecture, it may be worth bearing in mind key factors that are likely to exert an impact on the market.

Industrial output

Industrial production is expected to continue to grow, albeit slower. Although most economies are in slowdown mode, the US, Japan and Russia are showing stronger signs of a positive change in momentum as per the latest OECD leading indicators which, in turn, raise hopes of modest global industrial production growth through 2012. To be sure, industrial output growth tends to lead to higher average commodity prices.

Inventory levels in the physical market are running low. There has been a spate of destocking by consuming industries, especially in the metals space. No doubt, demand is trending flat to down, but it is by no means collapsing. Financial market worries and tightening credit have turned user industries cautious. Many want to conserve cash and reduce working capital. Sooner or later, restocking demand will have to emerge. This is especially true of China.

Supply uncertainties may continue to dog the commodity markets, as in the past. Labour action, delays in project execution or underperformance of existing projects cannot be ruled out. If anything, cost of production is likely to rise. If supply growth struggles to match demand growth, any supply response will come at a higher cost.

China policy

Chinese policy will have a critical bearing on global commodities, whether energy, metals or agriculture. 2011 saw a steady credit squeeze with the aim of cooling an economy seen to be overheating. To what extent credit tightness will be eased remains to be seen, although there is reason to believe, the policy stance has been effectively reversed.

The silver lining for the world market is, of course, the strengthening of the Chinese yuan, which makes imports less expensive. Will the growth rate be sufficient to whet consumption appetite? Interestingly, Chinese demand is generally counter-cyclical to the rest of the world and picks up when growth can be fuelled without inflationary worries, as some experts have observed.

The role of commodity funds, as usual, will be a crucial factor for the market. After exiting their long position last year, currently, funds are sitting on the fence, awaiting opportunity. Their time will come if the current pessimism gives a definite way to cautious optimism. In the event, commodity fundamentals will show the way for funds. Those with constructive fundamentals, such as crude and copper to name just two, will find investor interest which, in turn, will push prices higher.

Overall, in terms of price action, one can expect relatively weak progress in the first few months of 2012. But sustained flow of positive macro data and renewed confidence in China, hopefully towards the second half, will generate higher levels of economic activity and bolster commodity prices.

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