By Chris Shaw
In what marked a significant change in investor attitude, commodity prices in July experienced one of their largest corrections since 1980. Much of it due to a fall in oil prices. Like others, Danske Bank sees the correction as a test of whether or not the bull market in commodities is over, taking the view that while risks remain, the fundamentals are still supportive.
While an oil price of more than US$140 per barrel was probably excessive, the recent correction is more the result of demand destruction, in the group's vie. This is evidenced by US gasoline demand in the past month, which is down 3% from the same time last year. The decline being mainly due to total miles driven being slipping 3.7% in May from a year ago.
The weakness across the commodities sector sparked by the oil price correction may well continue over short-term, in the group's view, given it signals a change in sentiment. However longer-term market fundamentals still suggest prices can go back up. The bank has lowered its forecasts for the September and December quarters as a result, but its 2009 numbers remain essentially unchanged.
Looking firstly at oil, the group points out non-OPEC supply remains a big problem, with OPEC continuing to adopt a hawkish stance. Demand from Asia and the Middle East also remains strong, so the supply/demand situation remains in favour of higher rather than lower prices.
As well, the group notes net speculative positions are essentially square at present, meaning the recent decline is not being driven by traders but by a reassessment of the outlook for the market. While this is currently tilted in favour of lower prices, issues such as geopolitical tensions in the Middle East and unrest in Nigeria could quickly see sentiment again turn bullish.
There is also scope for production issues to emerge during the US hurricane season. Coupled with likelihood for OPEC to roll back recent production increases, there are several production catalysts that could push prices higher.
Danske has however acknowledged the prevailing change in sentiment, trimming its numbers. The group is now forecasting average Brent Crude prices in the September quarter of US$127 per barrel and in the December quarter of US$124 per barrel.
Such outcomes would equate to a 2008 average price of US$116 per barrel, with the group is forecasting an average of US$128 per barrel in 2009.
Turning to the base metals, the group suggests the sell-off in the oil has flowed through and impacted sentiment in the metals sector. Nickel has borne much of the brunt, finishing down 15% in July and 40% year on year thanks largely to weak stainless steel demand.
Falling oil prices have also removed some of the upside potential for aluminium prices seeing this metal come under some pressure of late. However, with energy prices still high in historical terms, there appears to be only a limited downside, in the group's view, given the energy intensive nature of aluminium production. Also supportive is the fact China continues to experience power supply issues, which is limiting production.
Copper has been far more resilient than nickel and has been able to hold at levels of just under US$8,000 per tonne thanks largely to supply side issues in Chile in particular. The group expects a continuation of such issues through 2009 and so remains positive on the metal leading into next year.
In the very short-term though, the group notes both copper and aluminium prices could come under further downside pressure. Such an outcome would however be short-lived, in the broker's view, and so the metals still offer opportunity for investors.
With gold prices crashing down below US$900 per ounce in recent sessions, the group's technical analysts have taken a closer look and conclude the longer-term bull trend remains intact despite the weakness. Analysis suggests the correction is unlikely to be more than 38.2% of the last bullish move (a Fibonacci retracement), which suggests prices could come down as low as the US$740 support level before the bull trend reasserts itself.
Any move above US$897 per ounce would cancel the correction, in the view of the technical analysts, leaving potential for prices to move to a new high at around US$1,072 per ounce.
