Commodities | Jun 21 2017
A glance through the latest expert views and predictions about commodities. Oil; gold and silver; zinc and lead.
-Has the oil market become too bearish?
-US Fed the main risk for the gold outlook, Macquarie suggests
-Ongoing weakness in silver market expected
-Downside risks to zinc supply suggest deficit to continue
-Lead prices likely to drift around current levels
By Eva Brocklehurst
Oil
Bearish sentiment has pervaded the oil market, Citi observes, and this has triggered an unwinding of investor long positions on financial crude futures. Yet the broker believes the change in sentiment has not matched the fundamental backdrop, and several misconceptions about the current market are keeping oil prices depressed.
Citi points out that a combination of the drawing down of physical oil inventories from record highs, given a financial crude futures curve in which investors are increasingly active, is always going to be a bumpy process. The broker points out money market short positioning is prone to sharp reversals and upward momentum can quickly be generated as, and when, sentiment improves.
On the other hand, outright investor long flows tend to be slower to move and probably need oil prices to move sustainability higher in the second half.
The main misconception is the state of storage and market balances for the next 18 months, in the broker's opinion. Optics suggest that OECD inventories have increased in the year to date whilst non-OECD inventories and floating storage have both fallen.
Citi believes this latter observation is misconstrued, in that deferred crude futures are not an accurate predictor of where oil prices will go. The broker believes this is, instead, indicative of lopsided corporate investor flows and a bad predictor of future oil prices. On base case US shale production estimates, the broker suggests markets are unlikely to be in surplus until mid 2018 at the earliest.
Gold And Silver
Macquarie believes the US Federal Reserve is the main risk, and opportunity, around gold. The broker contemplates two likely scenarios, both of which mean higher gold prices. Raising rates despite low inflation while promising more appears bearish for gold in the short term but, ultimately, the broker believes the Fed will realise it cannot deliver the said rate hikes, or it makes an error, hikes and risks recession.
The US Fed Funds rate is now 1-1.25%, a percentage point higher than its low. Rising rates are generally envisaged to be bad for the gold price and gold has descended to below US$1250/oz. Yet the broker warns correlation is not causation and such analysis risks being simplistic. Historically, gold has done quite well during cycles when the US Fed is hiking rates. At this point, the broker suggests fading US political risks are the factor behind the recent sell-off.
Macquarie's US economists calculate, based on worsening demographics in the US and falling long-term growth potential, that Fed's "neutral" rate is just 1.75%. Therefore, if the Fed insists on tightening rates as current projections suggest, it risks a policy error and recession. This would, in turn, be supportive of gold. Macquarie expects gold to average US$1250/oz and US$1325/oz in the September and December quarters respectively.
Since 2008 the annual supply of new gold has grown by around 800t/annum, an increase of around 30%. This growth has been driven by the rise of China, Russia and Mexico as major gold producers as well as new mines starting up across Africa, outside of South Africa, and a recovery in mature jurisdictions such as Canada and Australia. With this background, Metals Focus expects production growth to grind to a halt this year.
The March quarter signalled a marginal contraction, as supply declined by -0.4% year-on-year. Chinese output fell around -10% in the quarter largely from stricter environmental regulations targeting the discharge of cyanide in tailings, which meant a number of marginal operations were forced to close. The Metals Focus analysis shows over 90% of mines were profitable in the March quarter and supply will hold up in the near term.
Meanwhile, ongoing market weakness in silver is expected. Research has confirmed the extent of the drop in US silver coin and bar demand last year, estimated at -18%. This is been supported by several factors, as silver prices have been largely tied to a range.
The analysis suggests the price needs to break out significantly, perhaps falling to a low of around US$14-15/oz to help attract retail investors. Another reason for the ongoing weakness is the prospect that the market has become saturated.
Finally, there has been a jump in the selling back of coins and bars into the secondary market which has reduced the need for dealers to buy newly fabricated product. Metal Focus forecasts a -20% decline in 2017 in silver demand, to around 78m ozs and the lowest level this decade.
Zinc And Lead
Tightening supply has caused both zinc and lead prices to rally in 2016 and markets have cautiously embraced this story so far this year. Citi expects zinc supply to grow by 2.0% this year and lead 1.8%. Nevertheless, the broker notes increasing downside risks to zinc supply forecasts.
Citi suspects investors may be slow to adopt a favourable outlook on zinc into the September quarter, although the emergence of several constructive themes defies an outright bearish view. Based on historical mine strikes in Peru, and noting the call for a general strike on June 19, the broker suspects the disruption could hold back around 10,000t of zinc in concentrate from Antamina, the country's largest mine.
On the demand side, the closure of several Chinese smelters has prompted a pick-up in refined zinc imports in April. There is also surprising resilience in property commencements in China, despite government controls. Taking these factors into account Citi expects a zinc market to remain in deficit this year and into 2018.
Lead, meanwhile, has derived price improvements from a spike in refined imports to China but Citi suspects this situation is unlikely to persist for the rest of the year. Citi does not expect London Metal Exchange lead prices will surpass zinc over the medium term, particularly as scrap supply is catering for more than half of global lead consumption.
Rather, modest expectations of a deficit are a function of poor mine output. Citi expects a modest deficit in 2017 with global mine supply roughly in line with expectations, despite a ramp up in Chinese production. Absent an outsized boost to mine output the broker suspects lead prices will continue to drift around current levels for the rest of the year.
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