TRADE FINANCE AND LENDING, MACRO AND MARKETS
Commodities roller coaster continues
21 July 2022
The conflict in Ukraine, resurgent inflation and the drop in China’s building sector have all contributed to a volatile first half of 2022 for commodity prices. flow’s Clarissa Dann shares insights from Deutsche Bank Research on their outlook for the months ahead
Following a period of price volatility seldom equalled in global commodity markets, the Bank of England (BoE) announced on 5 July 2022 that there was a “significant risk” of further disruption to the system in the months ahead.1
The BoE also called for greater transparency, as the “particularly opaque” nature of some markets prevents authorities and market participants from gaining a clear view of overall trading positions. It highlighted a complex range of interlinkages between the financial and commodity markets that pose a risk to global economic stability, with prolonged disruption and uncertainty having the potential to make banks less willing to extend credit to market participants.
“Western demand is visibly slowing as central banks fight stubbornly high inflation, although recovering activity levels in China should provide a counterbalance”
In their Industry Update issued on 28 June, ‘Commodities Outlook: Late cycle anxiety’, Deutsche Bank Research’s team of analysts assessed whether the second half of 2022 and beyond would prove as turbulent as the first half, based on the Bank’s view that a 2023 recession is now likely in the US and other developed economies.
Figure 1: Illustrative early recession scenario
Source: Deutsche Bank, Bloomberg Finance LP
As they noted, there is already evidence of slowing Western demand for commodities as central banks battle inflation. Recovering business activity in China and the easing of strict Covid-19 restrictions (although more recently reimposed in several cities) should offset this until Q4 2022 when the team expects prices to succumb to weaker global economic growth.
What could this mean for the price of crude oil? Based on Deutsche Bank Research’s analysis, it could continue in the region of US$100– US$115 per barrel (bbl) in the near term with “strained refining capacity” before increasing demand concerns and signs of a growth slowdown provide a moderate easing to US$90/bbl in 2023.
The anticipated scenario sees a low refined product inventory for the remainder of this year “even as refineries raise utilisation in response to high margins” and a further possible decline in Russian production, although some output has been redirected from the West to Asian buyers. Continued withdrawals until end October from the US Strategic Petroleum Reserve (SPR), the world’s largest supply of emergency crude oil, will deplete much of its sour crude inventory “leaving sweet crude, which is less in demand by US refiners”.
The outlook is similar for metals, although supply shocks “have been a recurring theme” since early 2020 and the onset of the pandemic, meaning supply is “structurally tight following several years of underinvestment” even from regions not directly impacted by the Russia-Ukraine war, such as Australia, Brazil and other Latin America producers.
With a global recession regarded as increasingly likely within 12–18 months, metals prices should ease but at higher levels than those seen in other recent downturns in 2015–16 and 2020. The Industry Update concludes that “a recession will only further delay the much-needed supply response and make the next upturn even more powerful”.
As flow has previously noted, China’s status as the world’s second-biggest growth engine means that its economic health has almost as great a bearing as the US on the course of commodity prices, particularly metals.
Deutsche Bank Research’s analysts report that demand has weakened since mid-2021 primarily due to a downturn in the Chinese property market, despite government policy shifting last December to a more supportive, pro-growth setting. Subsequent zero-Covid lockdowns stifled a nascent recovery in activity. “The housing recovery has been slower than expected: recent data shows a rebound in sales from April lows, although a sustained recovery in construction activity may not come through until late 2022 or 2023,” notes the Industry Update.
On 14 July 2022, in the news story headed, ‘China property crisis enters next dangerous phase’2, Reuters summarised the current precarious position of homebuyers refusing to meet mortgage payments for homes not yet finished by developers. “New launches are almost always sold before they are built. When heavily indebted developers run out of cash, buyers are left with nothing but a debt obligation,” observes Thomson Reuters’ Yawen Chen.
An earlier Reuters report (5 July) noted that it had heard reports that China is setting up a state infrastructure investment fund worth 500 billion yuan (US$74.69bn) “to spur infrastructure spending and revive a flagging economy”.3
This demand for construction commodities is likely to see a “relief rally”, forecasts the Deutsche Bank Research team, with commodity prices temporarily buoyed by China’s rebound before they “succumb to weaker global growth and some degree of supply recovery across the complex, reaching a trough around the middle of 2023”.
This scenario is reflected in the outlook for copper, where prices have been in retreat since March although escalating geopolitical tensions and copper output in major producers Chile and Peru is 4.5% lower year-on-year in the first five months of 2022.
With China’s “tepid activity” now reviving, a brief stimulus for copper is expected in Q4 before slowing demand elsewhere in the world and output from new mines such as Chile’s QB2, Peru’s Quellaveco and Kamoa-Kakula Phase 2 in the Democratic Republic of Congo create a supply surplus and bear downwards on prices in 2023.
A deeper recession than anticipated could create an even bigger surplus, but the team believes that “the relatively low level of global inventories, coupled with accelerating investments into renewables and electric vehicles (EVs), should limit the downside” making it less pronounced than previous downturns, such as 2015-16. As early as 2025, a surplus of copper could be replaced by “sustained deficits”.
Figure 2: Peak to trough metal prices have fallen an average of 40% into a US recession/major downturn
Source: Deutsche Bank, Bloomberg Finance LP
Troughs and rebounds
“Gold prices have remained remarkably stable in light of the most extensive Fed hiking cycle in quite some time”
Iron ore prices have also been on a downward path after an increase in Q1 resulting from recovering steel output in China, the impact of war in Ukraine and bad weather-related disruption from major exporters Brazil and Australia. The spot price rallied from a trough of US$90 per tonne in November 2021 to edge above US$160/t by early April.
Since then, the rally has reversed on a combination of recovering exports, demand concerns in China reflecting high steel inventories, weakening mill margins and looming steel cuts in Q3 both in China and globally. But by Q4, the team expects a retightening of the market as steel demand in China recovers seasonally and cyclically. Following negative growth in 2021 (-3%), the forecast is for a smaller dip in 2022 (-1%) and a return to growth in 2023 (+1%). Outside of China, steel production should “improve” to close to flat next year after a -4% fall in 2022, which suggests the price of iron ore should hold above US$100/t.
For the Platinum Group of Metals (PGM) the outlook is one of “cautious optimism”, with a brief price spike in the early days of the Russia’s war on Ukraine; however, Norilsk Nickel, Russia’s biggest producer of PGMs, reports no major disruptions to, or restrictions on, its output. The Auto sector team at Deutsche Bank Research believe that despite global macro concerns, electric vehicle (EV) production will rebound, assisted by low levels of inventory and improved chip availability, anticipating a 12% y-o-y rise in auto production this year and a 13% increase next year. As explained in the flow article, Powering electric vehicles – the commodities impact, incentives are expected to encourage a move away from palladium and accelerate substitution towards platinum in the long term. Battery powered electric vehicles (BEVs) are expected to continue to take market share, impacting PGM demand (unlike internal combustion engines and hybrid vehicles, BEVs do not use PGM metals). Although the fledgling hydrogen economy is likely to benefit platinum “to a certain extent” the team believes that demand from this segment “will be small until at least 2030”.
Gold has traditionally been regarded as a store of value in troubled times (as explained two years ago by Deutsche Bank Research’s former metals analyst Nicholas Snowdon on Trade Finance TV), and gold prices have remained “remarkably stable” at a time when the US Federal Reserve is hiking interest rates at a frequency last seen in 2004–06 before the financial crisis. But now the team is more bearish on gold’s prospects in the months ahead as US Treasury (UST) real yields have further to rise and FX safe havens – particularly the Swiss franc (CHF) and the Japanese yen (JPY) - regain their attractiveness to investors.
Summary of outlook
In summary therefore, according to the Industry Update, the picture is one of a bearish ex-China demand outlook, a Q4 relief rally for industrial metals but a recessionary pull lower in 2023, oil purported by its products market, gold inertia potentially breaking to downside and a continued move away from palladium to platinum.
Deutsche Bank Research report referenced:
Industry Update – Commodities Outlook: Late cycle anxiety by Liam Fitzpatrick, Michael Hsueh, Bastian Synagowitz, Abhi Agarwal, Corinne Blanchard and Edward Goldsmith (28 June 2022)
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