A strong start, with some firm underpinning. That’s the view of Barclay’s who note that commodity prices have increased slightly since the start of the year despite turmoil in several emerging markets, concerns about slowing activity in China and a strengthening dollar. The BRIC-40 equity benchmark index is down by over 8% since the beginning of January. As Barclays note given that this group of countries is where well over 50% of global commodity demand now comes from, and that it has accounted for nearly all the demand growth in recent years, the price performance of commodities looks very robust in comparison.
Some of the recent price support may prove to be transient. First, from an investor point of view commodities entered 2014 with speculators underexposed to the sector meaning that there could be little left to sell and minimal downside. Second, in many commodity markets prices are close to costs. Barclay’s estimate that almost 60% of aluminium producers are unable to cover cash costs. However, that’s not to say that prices cannot remain below cost for substantial period of time as producers may be unable or unwilling to cut production. Third, the weather with extreme cold in the US supporting natural gas as well as other energy prices.
However, higher commodity prices may have some firmer underpinning. There has been a gradual but sustained tightening in price spreads with commodity futures curves moving towards backwardation. Of the 24 major commodity markets, 10 are now in backwardation including some of the primary markets including crude, soybeans, copper and natural gas. As Barclay’s notes the correlation between commodity fundamentals and price spreads is usually quite high, certainly tighter than between fundamentals and outright price levels. So this tightening up in commodity futures curves is likely a leading indicator that underlying conditions in commodity markets, either via gradually improving demand, supply-side attrition or a combination of both, are getting healthier.
However, as we note in another article today the canary in the room (China’s equity market) offers little support.