G Chandrashekhar

How will commodities fare in 2017?

G Chandrashekhar | Updated on January 15, 2018

Grain of truth Commodities face uncertain times   -  Bloomberg

Prices will recover, albeit slowly; watch out for changes in geopolitics, central bank policies and weather patterns

Global commodity markets are impacted by a host of factors; and given the dynamic nature of these factors, a constant update of the magnitude of change and its effect on market fundamentals are critical for commodity traders to take informed trading calls.

To be sure, there are five broad factors that drive the global commodity markets. The drivers are: economic growth; geopolitics; monetary policy; currency; and weather. All the five are expected to play out in 2017 in varying degrees and impact the world commodity markets — covering energy, metals and agriculture — in varying measure.

Growth pangs

According to the World Bank, global economic growth will accelerate moderately to 2.7 per cent in 2017 after a post-crisis low last year. While overall prospects for emerging market and developing economies are dampened by tepid international trade, subdued investment and weak productivity growth, China is projected to continue an orderly growth slowdown to a 6.5 per cent rate. Russia and Brazil resume growth after recessions as commodity prices gradually recover under the lead of crude oil.

The positive relationship between economic growth and commodity consumption is well known.

With demand set to kick in, albeit slowly, consumption is expected to pick up. This is positive for growth-oriented commodities such as crude oil, steel and base metals.

From a geopolitical perspective, the situation is nearly normal with no sign of any major instability. Geopolitics drives commodity prices, especially gold and crude oil if originating around oil exporting nations.

However, the recent agreement among major oil exporting countries to curtail output in order provide a boost to prices is expected to tighten supplies at a time when demand is beginning to show signs of slow revival.

The US shale oil output is beginning to rise too. So, crude prices in 2017 may average $55 a barrel, nearly double the lowest price reached a year ago (February 2016). Rising crude oil rates (with occasional spurt above $60 a barrel) will impact commodity production costs, especially metals and agriculture.

Changing times

In the past 7-8 years, the world saw divergent monetary policies with developed countries (especially USA) adopting a highly accommodative policy while emerging markets such as China and India attempting to tighten liquidity. The situation has turned now and the divergence has widened.

While the US Fedis set to hike interest rates and tighten liquidity on the back of positive macro data, Europe follows an ultra-easy monetary policy and Japan a negative interest rate policy. Emerging markets like India are in the process of expanding liquidity to boost growth.

Clearly, the period of liquidity-driven commodity price boom is well behind us, ending as it did towards late 2015.

Currency gyrations continue to impact commodity prices. Continued flow of encouraging macroeconomic data from the US over the last several quarters and tightening monetary policy has lent incredible strength to the US dollar against all major currencies like euro, yen and yuan.

A strong dollar usually caps the upside for commodity prices designated in dollar terms. 2017 is expected to see the greenback continuing to stay strong and impact commodity prices.

From 2013 onwards, for four years in a row, the world in general and northern hemisphere in particular experienced benign weather barring some aberrations such as El Nino in South East Asia and parts of South America. Largely favourable weather has meant a rebound in crop production, rising inventory and softer agri-commodity prices including grains, oilseeds and cotton.

Stays that way

The situation is unlikely to change in 2017 despite incipient signs of La Nina earlier and lately El Nino. But weather experts have asserted that the situation is by and large neutral and no significant weather hiccup is expected this year on current reckoning. In other words, 2017 will most likely be yet another year of normal grains, oilseeds and cotton crops. This is likely to make availability comfortable and food prices by and large stable.

Improved supply outlook also means that speculative capital will more likely continue to stay in the sidelines as far as farm goods are concerned. Sugar could be an exception as shortage in India and need to import may propel global sugar prices higher.

As for base metals, there is a case for being selectively bullish (nickel, zinc) with supplies poised to tighten amid creeping demand growth, in advanced economies as well as in emerging economies such as China and India.

As for gold, the safe haven appeal is waning. Enervated demand from two of world’s largest importers and consumers (China, India) combined with a firm dollar and improving equity market means that the yellow metal will come under downward price pressure and trade below the psychological $1,200 an ounce.

Commodity prices had a dream run from 2010 till 2014 in the wake of accommodative monetary policies, weak dollar and robust demand growth under the lead of China.

This was followed by a collapse triggered by crude oil and demand slowdown. The market seems to have bottomed out and there are signs of recovery. However, there could be headwinds that can potentially retard the pace of price gains.

Elections in three European countries, crude oil prices and Trump administration-induced market volatility including protectionist tendencies are risk factors that cannot be overlooked.

The writer is an agribusiness and commodities specialist

Published on March 20, 2017

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