Commodities under pressure as China continues economic realignment

Toronto (Oct 9)   Commodity prices will continue to face near-term challenges that are linked to the dip in Chinese growth. However, support is likely to come from the country’s new economic agenda, Scotiabank VP and commodity market specialist Patricia Mohr told attendees at the recent Global Chinese Financial Forum.

Gold will come under greater pressure as the US recovery gathers pace, while some opportunities are apparent in base metals, particularly with zinc. “In addition, because of the tremendous expansion in US and Canadian oil and gas production, there are some excellent prospects in the pipeline and railways sectors,” Mohr said.

NEW ORDER

China dominates the global base metals market, accounting for 46% of global demand. Given this, the country’s economic fortunes are closely monitored, with any dip in growth potentially representative of a reduced metals uptake. Chinese gross domestic product (GDP) growth for 2014 will be over 7%, which compares with 7.7% in 2013, Mohr said.

In the long term, support for commodities will come from China’s new economic agenda that was born out of a leadership change in 2013. One of the agenda’s central goals is to spur greater urbanisation to underpin growth and boost further infrastructure investment.

One of key platforms here is to speed up rural land reforms and allow families a better chance to obtain municipal citizenships in order to live in major Chinese cities, such as Shanghai. In addition, the inflow of people will require new and improved housing, both social and private, which will act as another lift for commodities.

The leadership is also keen to loosen some of the controls enjoyed by state-owned companies in several sectors, increasing the role of market forces in allocating resources. “For example, the government wants to decontrol energy prices,” Mohr said.

Among the agenda’s proposed fiscal reforms, the Communist Party wants to deleverage municipal finances and improve the alignment of municipal spending obligations with revenues. Some of these spending obligations will shift to the central government, while the municipalities will also be allowed to issue debt.

“This is an important issue for the financial markets in London and New York, where the high debt levels of municipalities in China has been a source of concern,” Mohr stressed. “Remember it was the municipalities that financed the huge infrastructure development [in China] coming out of the 2008 global recession.”

TAPER TIME

Away from China, the economic performance of Europe has been moderate-to-flat, with second-quarter data from several eurozone jurisdictions a cause for concern. Meanwhile, Russian growth has stagnated in 2014, reflecting the impact of sanctions imposed by Europe and the US following the developments in Crimea and eastern Ukraine.

The US outlook is much brighter, with the economic revival continuing to pick up and the robust second-quarter GDP growth figure of 4.6% illustrating this. The calendar-year 2014 figure will stand at about 2.2%, affected by the first quarter’s 2.1% negative growth that was mainly owing to a severe winter. Scotiabank believes the growth figure for 2015 will be above the 3% mark.

US employment figures have also improved and are seen as another sign of revival. “Employment growth in the past six months has been quite good, which is why Janet Yellen [chair of the US Federal Reserve] is now gradually reducing the liquidity injections into the US economy,” Mohr said.

Quantitative easing (QE) liquidity injections have been tapered from $85-billion a month to $15-billion a month and the debate is now focused on when, not if, interest rates will rise. “We think the Fed will end their bond purchase programme [QE] in October this year,” Mohr added.

“Mrs Yellen will then wait six months before lifting the Federal funds rate, which are currently at the bottom of the interest rate curve,” she said. “This means 2014 will be the last year when interest rates stay as low as they have been, so you should prepare yourself for an environment when interest rates start to rise.”

UPS AND DOWNS

Mirroring the US economy’s growing vigour, the US dollar is also strengthening. This is putting increased pressure on gold as the yellow metal’s safe-haven status loses its lustre among many investors.

Concurrently, the tightening of US monetary policy is acting as another weight on the yellow metal. “Gold’s bottom last year was in June 2013, when it reached $1 180/oz. This happened after then-chair of the US Federal Reserve Ben Bernanke announced he would probably start reducing QE,” Mohr said.

“Every time the Fed makes an announcement that points towards tightening monetary policy, gold pulls back,” she added. “I expect gold prices to fall into 2015, while we have an average of $1 225/oz for next year. In the medium term, for 2016-2017, it will move back up over $1 300/oz, possibly as high as over $1 400/oz.”

Gold’s medium- to long-term prospects will be supported by reduced physical supply as marginal operators cut production or shutter mines. “And I think that physical supplies will be quite tight into the second half of the decade,” Mohr added.

For base metals, Mohr highlighted zinc as a good opportunity and one that stems from a tightened supply scenario that is now in effect. The situation has been bolstered by the closure of several mines in Canada and the pending closure of other zinc operations next year, including the major Century zinc mine, in Australia, next year.

“LME [London Metals Exchange] official cash settlement prices for zinc will average about $1/lb this year. We think next year will witness $1.25, moving up as high as a $1.60 in 2016, which is a strong performance,” Mohr said.

But from an investors’ perspective, perhaps some of the best opportunities are to be found in oil and gas infrastructure, specifically Canadian pipelines, as the country sought to embed greater capacity and export oil to markets beyond the US, either through eastern Canada or British Columbia.

Tied to oil exports, Canadian railway companies also present favourable opportunities. “Right now, one of my key picks for investors would be Canadian Pacific Railway because of huge volume gains and because they’re also shipping a lot of oil. Canadian National Railway is also a very good pick,” she said. “They all pay dividends and are probably going to move higher.”

Source:  MiningWeekly