China, Trump and OPEC
In 2016, three strong driving forces have emerged and pushed up commodities to the best asset class, with the index up by 30% in USD terms. For 2017, we be-lieve that only one of these will be able to exceed ex-pectations, and that is not Trump or China, but OPEC.
OPEC exceeded expectations
The bi-annual OPEC meeting in Vienna was a show of strength from the slumbering cartel. A package com-prising three strong components was presented: pro-duction quotas for each member country, a produc-tion ceiling for Iran and an agreement with non-OPEC producers, with Russia accounting for the largest re-duction. The market doubts its implementation; histor-ically OPEC has delivered about 80% of its agreed production cuts. On this occasion, we have confi-dence in OPEC and envisage a good equilibrium in the oil market during the second half of the year. This will lead to an average oil price of USD 60 for 2017, a significant increase from the previous forecast of USD 40.
China + Trump = base metals
The recovery seen by China this year originated in the focused stimulus measures toward the property mar-ket and infrastructure in 2015 - a tried-and-tested method that consumes a lot of industrial metals. China is now taking steps to cool the property market and this will lead to lower growth rates in investments and infrastructure in 2017. Trump's inauguration as Presi-dent will probably increase expectations still further during Q1, but there is then a risk of disappointment both in the US and China. Zinc and nickel are well placed in the supply side of the price equation, while copper and aluminium will be weighed down by high production. Compared with 2016, we see higher prices for all base metals in 2017 but consider the spot pric-es to be too high for all metals except nickel.
OPEC changes strategy
Not since the intense financial crisis of 2008 has OPEC agreed to reduce the production of crude oil. The decision at the extra meeting in Algiers in September to move from two years of deliberately low prices to an attempt to cut production came as a total surprise. Given the change in Saudi Arabia's rhetoric prior to the meeting, it was clear that something was going to happen. The country has come under increasing pressure after two years of budget deficits. The power struggle ended with Iran gaining the upper hand and Saudi Arabia finally deciding to make a U-turn. Now there is a great deal to prove. In the past, implementation has always been more difficult than decisions for OPEC, but we believe that the discussions will be enough to provide oil with support of around USD 10. We raise our year-end price expectation from USD 40 to USD 50.
China's "mini-cycle" becoming a "medium cycle"
As a group, base metal prices have now gained for three successive quarters. That has not happened since the re-covery after the financial crisis in late 2010/early 2011. China's recovery this year stems from stimuli targeting the property market and infrastructure, a tried and tested method that consumes a substantial amount of industrial metals. We previously believed that the cycle would start to slow in the middle of H2, but incoming data is still quite strong, so we expect base metal prices to continue rising.
Will the Fed make its move in December?
The most recent wave of bank-related turmoil in Europe, centred on Deutsche Bank, has not awakened investors' needs for a safe haven in gold in the same way as previ-ously. Following a sharp climb after the Brexit referendum, gold has come under a certain amount of pressure. We believe that market expectations of a Fed hike in December are creating a temporary aversion to gold. After a hike, we see new opportunities for gold and silver, but the current situation for this year is weaker, as only one rate hike has been signalled for 2017.
Supply disruptions balance the oil market
The oil price has risen substantially since March, when we believed that its next movement would be down. Increased activity in the shale oil fields, which we expected then, is beginning to show now, nearly three months later. This shows what pressure shale oil producers have been under. At the same time, supply disruptions have rapidly improved the market balance. As far as the second half of the year is concerned, it will be particularly difficult to assess how Nigeria's and Venezuela's complex production will develop. We still think prices will drop somewhat, but not as much as in March, and we see a clearly increased upside risk in our price assumption, with Brent at around USD 40/bbl by year-end.
Base metal prices diverge
Of our key cases this year, zinc prices have taken off, rising by 30% year-to-date. However, nickel has remained still, even though the market balance looks increasingly strained. After the zinc increase, we see nickel as the main commodity with a chance of a 15% price increase by year-end, with USD 10,600/t as our target price. We keep our year-end forecast for zinc at USD 2,200/t and lower our copper forecast from USD 5,000/t to USD 4,500/t, as mining companies continue to increase production and China is not meeting growing demand.
Fed indecisive and Brexit looms
Fed Chairwoman Janet Yellen recently stuck to her earlier statement of two rate increases this year. The strong correlation of gold and precious metal prices to whether the Fed raises rates creates a downside risk for precious metals, as two increases have not been priced into the market. On the other side of the scale is this week's outcome of the UK referendum. We believe that a clear "leave the EU" outcome, say 60-40, will spark a new sustainable increase in the gold price, where the upcoming elections in Spain, Belgium and the Netherlands may stimulate an increased interest in gold as a safe haven.
Lower oil prices in next movement
After the oil price rise in March, we are now seeing several signs that this journey is reaching the end of the road and that the next movement will be downward. Shale oil is no longer flowing, Nigeria and Iraq have had production disruptions and let us not forget that the market is speculating about decreased production from OPEC and Russia. We are contrary to the consensus opinion and believe that all these forces are behind us and that the price will reach USD 30 rather than USD 50.
Mining companies strengthen base metals
While the oil price bottom is still ahead of us, we believe that base metals have hit the cyclical bottom after four years of decline - at least as a group. Copper production still looks a bit too high but for zinc, nickel and aluminium, there has been a massive rebalancing of the market on the producer side. We see zinc as the base metal with the best fundamentals and raise our forecast to USD 2,100.
The Fed caught in a trap
The Fed's weak rate hike has led to the largest rise in gold over three months since the euro crisis was at its peak. The feeling that the Fed has ended up in a situation where it cannot control the economy by means of the interest weapon creates a strong need by investors to park some of their money in a safe-haven. We do not believe that the Fed's situation will improve in the next six months, and although gold has already passed our strong belief of a 12% higher price this year, we are raising our forecast to USD 1,300.
Spring rally for coffee but weak wheat prices
After the winter, wheat prices have come under pressure, with high safety stocks worldwide and good conditions for the new harvest to be good. Coffee prices have jumped by 18% in March. Rising coffee prices in the spring are not unusual and according to the seasonal pattern, the price usually holds up until May.
2016: a new volatile year for oil
During the last two weeks, the impact of OPEC abandoning its production target and the end of the drop in US shale oil production alongside Iran's approaching return have all been traded into the oil price; consequently, the oil price has fallen below USD 40/bbl. Of these factors, we consider Iran's approaching return to be contributing the most to oil price movements, although the impact from shale oil is difficult to interpret. As long as 2016 does not bring about a total collapse in shale oil, we see few arguments for prices to increase and believe that Brent will reach USD 30/bbl during the first six months of the year.
Base metals to decouple
During 2016, we think that there will be greater potential for base metal prices to perform based on their own fundamentals. We continue to believe in the emergence of a zinc shortage and see no reason for copper to continue to trade at a premium to its production cost when there is a growing surplus. As examples of how base metals may decouple, we expect that copper will approach USD 4,000/tonne and that zinc will increase to USD 1,900/tonne during the first half of the year. We expect that aluminium will continue to have lower production costs and for the price to establish itself at a new, low level. For nickel, we see clear signs of a turnaround, which may result in that metal being the wild card in the pack at USD 9,800/tonne.
Will the Fed manage to be sufficiently soft?
We have now seen the first start of an interest rate hike cycle in nine years in the US. Since the Fed moved away from its expansionary monetary policy, which pushed up the price of gold to peak levels in 2011, the gold price has fallen by 44% to price in what is now a contractive monetary policy. The question for 2016 is whether the Fed will manage to continue to increase interest rates. If there were to be economic development where the Fed would be perceived as having painted itself into a corner and unable to control the economy through rate increases, it would certainly lead investors towards gold as a safe haven. We are using this scenario to justify the risk of a higher gold price in 2016.
US strengthens wheat prices
Following the price decreases in 2015 for soybeans, wheat and corn, we are not quite so negative towards these three major crops. Poorer plantings in Russia and a strong USD that hinders US exports have together created a fair premium for wheat in Paris.
Higher oil price expected
In our view, China and the US are the countries where the lower oil price should most clearly be converted into higher demand. The recent turbulence in China has lowered expectations regarding China's demand for commodities. Demand for metals and steel in China is weak, but oil is a 70% consumer commodity, which is not affected in the same way by lower industrial production and lower investments. Following the shift in market expectations, we believe that the risk to the oil price is on the upside for the next six months of up to USD 60 per barrel.
China reduces base metals
The turbulence in China in late summer dampened the outlook not only for a recovery, but also for continuing growth in China's consumption of metals. Steel consumption growth has now been negative since mid-2014, and this summer it fell to -7%. Using the value of steel consumption as a proxy for the economy, it is difficult to reconcile the steel recession with the GDP growth target of 7%.
Precious metals more sensitive to the Fed
The Federal Reserve continues to postpone the funds rate hike; this has again blurred expectations, which previously were focused on a hike during the second half of this year. Now, we have to look as far ahead as June 2016 before the fixed income market fully prices in a rate hike. Gold and silver have proved to be increasingly sensitive to data that affect the funds rate announcements. Gold and silver have strengthened on the back of negative data, and vice versa.
Slow wheat harvest
Following the latest price decreases for soybeans, wheat and corn, we are not quite so negative towards these three major crops. We regard the drought in Russia as more of a short-term risk premium in wheat, and to a certain extent corn.