Global commodities prices broke down in the third quarter as they grappled with volatile global financial markets.
No longer, it seems, do markets believe the traditional view that lower commodities prices will have a beneficial effect on global growth.
Rightly or wrongly, the emphasis is on their disinflationary consequences, as well as on the damage done to the balance sheets of commodities-exporting countries and corporations, many in emerging markets.
Pressure on the commodities-producing majors last week turned into broad-based equity market weakness, as the interconnected nature of these companies across sectors and regions reinforced a flight to safety.
Although lower oil prices have exposed the high break-even oil prices of many oil-producing countries, including in the GCC, they have also drawn attention to the indebtedness of many global corporations such as Glencore.
The IMF highlighted the risk of corporate defaults in its latest Financial Stability Report, saying that corporate debts in emerging markets have leapt to US$18 trillion last year, from $4tn in 2004.
It also warned that this could create a credit crunch as risks “spill over to the financial sector and generate a vicious cycle as banks curtail lending”. Last week there were headlines about cutbacks in investment projects (Shell announced the suspension of Arctic drilling) and cutbacks in jobs.
Given these linkages, the outlook for commodities prices has taken on greater significance for the wider world. The weakness in commodities is linked primarily to fundamentals: there is too much of most commodities amid uncertain demand conditions. The most glaring indication of oversupply has been in the oil markets where the International Energy Agency’s latest data indicates a global surplus of 2.6 million barrels per day in the second quarter of this year.
This level of surplus was not far off adding the equivalent of another Kuwait (2.8 million barrels per day of production) to global markets. This burdensome surplus has pushed benchmark oil futures down 15.4 per cent since January for Nymex West Texas Intermediate crude and 15.6 per cent for Brent crude.
It is likely that we will see some signs of recovery in oil, but the degree of volatility affecting markets means there can be substantial downward lurches on the way to higher prices.
The surpluses are not restricted to oil markets. In the critical agricultural markets of wheat, maize and soybeans, all are estimated to be in oversupply, allowing stocks to build but also weighing down on prices.
Agricultural markets had been anticipating the most severe El Nino weather event in years to disrupt production this year and next year, but so far there has been no significant effect. El Nino may yet impact production of rice, palm oil and other tropical or Pacific crops.
Demand uncertainty has been affecting industrial metals throughout the year. The London Metal Exchange Index, which tracks the six base metals traded on the exchange, was down 18.6 per cent year to date at the end of the third quarter as prices plunged to multi-year lows. Industrial indicators from fixed-asset investment in China, company profits and property prices have all underperformed this year, casting doubt on the largest market for most industrial metals.
Gold and the precious metals have not suffered directly due to oversupply but mainly as a result of uncertainty about the trajectory of US monetary policy. The pending Federal Reserve rate hike is probably already priced into gold, but it may come under additional short-term pressure once the Fed actually moves. Platinum will show more divergence from gold as demand prospects weaken in the wake of the Volkswagen diesel engine scandal.
Aside from the need to work through the excess inventories affecting many markets, commodities will face several key risks in the months ahead.
Among the most notable which could impact all commodities are the uncertainties over China, with the slowdown there affecting emerging markets in general. While China’s oil demand grabs headlines, we should not discount the impact of other emerging Asian oil markets, of which the significant economies represented about 9 million barrels per day of oil consumption.
Finally, the trajectory of the dollar will also have an important bearing. All other things being equal, a stronger dollar which should follow the Federal Reserve raising interest rates should mean lower commodities prices, which could in turn damage emerging market demand prospects further.
Tim Fox is the head of research and chief economist at Emirates NBD, and Edward Bell is a commodities analyst at the bank.
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