Weather and China key drivers of commodity prices in 2014

Commodity price gains have generally been led by crops with weather concerns supporting prices. Drought in Brazil raising concerns that this and next years harvest will be damaged. The most surprising bar on this chart is natural gas since the so called ‘polar vortex’ over the US resulted in a surge in demand for heating while the extreme cold prevented rigs from responding. Natural gas prices peaked in mid-February at over $6 per mBtu (at the time up over 50% during 2014) but since then warmer weather has caused prices to fall, giving up virtually all its gains since the start of the year. The weakest commodity prices have been industrial metals where signs of a slow down in China coupled with concerns about commodity financing deals has reduced demand for the metals. The exception has been nickel where the introduction of an ore export ban by key supplier Indonesia means Chinese buyers are now running down their stocks and searching for alternative suppliers.

Chart: % change in commodity prices during 2014

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Source: ABN Amro

Related article: Chinese demand key to commodity prices in 2014

China’s commodity funding unwind affects commodities from Al to Zn

Here is Goldman Sachs take on the likely evolution of commodity funding deals in China.

Looking ahead, our view is that Chinese commodity financing deals will gradually unwind over the medium term (the next 12-24 months), driven by an increase in FX hedging costs, which would slowly erode financing deal profitability and eventually close the interest rate arbitrage…Finally, an abrupt government crackdown on Chinese commodity financing deals, even with an offsetting monetary stimulus package, is unlikely in our view, given the potential negative impact this could have on credit and thus economic growth…A continuous CNY depreciation in the short term, however, would trigger some deals to be unwound sooner than expected, and hence place downside risks to our short-term commodity price forecasts.

The fear is that a rapid unwinding in financing deals could mean that a lot of metal is suddenly released onto the market. Borrowers, forced by their bankers to repay loans would have to sell the metal into an already well supplied market and in the process push down market prices even further. Reports indicate that the recent falls in copper and iron ore prices were driven by speculators trying to anticipate the unwinding of financing deals. So far there has been little evidence of large scale physical selling. Despite the recent drop in copper prices Goldman Sachs estimates that the returns from copper financing deals are still in excess of 10%. At the moment not at the point when the deals are going to unwind putting further pressure on metal prices.

The bank also highlights the wide range of commodities that are being used to raise foreign financing, including iron ore, soybeans, palm oil, rubber, zinc, and aluminum, as well as gold, copper, and nickel. The gradual unwinding of commodity funding deals is likely to place downward pressure on all of them over the next couple years.

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Related article: Commodity prices could face hard landing as credit unwinds in China

Ukraine fears spook wheat markets

Wheat Field [E-X-P-L-O-R-E-D]
KevinLallier / Foter / CC BY

European wheat prices have risen by around 7% since the end of February to around £167 per tonne as Russia’s capture of the Crimea has spooked traders into evaluating the risk that grain exports from the Ukraine will be blocked. In the latest apparent worry for traders the Agriculture Minister for Ukraine suggested that the Crimea could remain unplanted due to fuel shortages. However, according to Noggers Blog the Crimea only accounts for around 1% of Ukraine’s total net grain output in 2013. Overall there has been no impact on spring plantings or grain exports from Ukraine following the recent unrest.  Meanwhile, Russian exports of grain look set to benefit from the unrest as the weak rouble spurs higher demand for wheat – the Russian Agriculture Ministry today revising their forecast for 2013/14 grain exports up from 20 million tonnes to 22 million tonnes. Still with Crimea due to vote this Sunday as to whether or not it breaks away from Ukraine, sentiment is likely to continue to see wheat prices being supported until the implications of the vote and any potential Western response becomes clear.

Related article: Could unrest in Ukraine have a sting in the tail for commodity prices?