Will 2019 be rocky for commodities?

Summary: The 2019 forecast for our major commodities – gold, iron ore, copper, nickel, battery metals, coal and oil. 

Key take-out: The way most commodities started 2019 is unlikely to be how they finish the year.

Mining and oil, like every other investment class, start 2019 facing multiple uncertainties. But if there is a rough guide to the year ahead, it can be found in the way 2018 flipped from good to bad at the halfway mark, with this year potentially being a mirror image – bad start and better finish.

The star of a troubled resources sector last year was gold. It is the commodity-cum-currency that benefitted from the instability caused by the China v US trade war, Brexit and rising US interest rates – though even gold had a year in two halves; down initially, then up.

There is a pattern in the way major commodities have been moving, reacting rapidly and negatively to reports of slower economic growth while ignoring underlying fundamentals which show that the future is not as bad as some people might suspect.

Michael Strobaek, global chief investment officer at the Swiss investment bank, Credit Suisse, has been one of the few experts to point out that there is a lot of good news to be found behind the cloud of negatives.

At the heart of his optimism is a view that the global economy continues to grow at a reasonable pace which will underpin demand for commodities. Prices for raw materials will be aided by an expected slide in the value of the US dollar, the currency in which most metals and oil are traded.

Strobaek has been arguing for some time that the future is not as dangerous as some investors might believe. He said in an internal Credit Suisse report in October that the bank’s investment committee had a positive view on equities and had turned from negative to neutral on government bonds thanks to rising yields.

“We also remain positive on commodities, which should benefit from a robust late-cycle growth environment,” he said.

Strobaek refreshed his upbeat view in late December when he said in a report written for London’s Financial Times newspaper that Credit Suissse entered the new year: “With a moderate growth tilt in our portfolios, expressed via a preference for global equities and commodities over fixed income and real estate”.

Credit Suisse is not alone in its view that there is a significant difference between the scare headline generated by the trade war and emerging political instability in the US and Europe. The latter faces the prospect of a damaging stand-off with Britain as it edges towards a ‘hard’ exit from the European Union, an event which will test the economy of the EU almost as much as Britain.

The difference between the politics buffeting commodity markets and the underlying forces of supply and demand were best explained late last year by the chief executive of Glencore, Ivan Glasenberg.

Speaking from his position as head of one of the world’s biggest mining companies which is also one of the world’s biggest commodity traders, Glasenberg pointed out that stockpiles of important metals had declined significantly over 2018, even as prices were falling. This was an event that defied basic economics with falling supply counterbalanced by rising prices.

Of equal importance is a sluggish outlook for investment in new mines which means that shrinking stockpiles are likely to continue shrinking, a trend which will inevitably reverse given the expectation of continued global economic growth.

Key measures used by Glasenberg include the availability of copper, a critical metal in multiple industries. Over the past three years the worldwide copper stockpile averaged around 17 days of consumption whereas it is now around 12 days.

Zinc stockpiles, which had been enough to meet 13 days of use over the past three years, now stand at seven days, while nickel’s 110-day stockpile has fallen to 66 days.

This decline in stockpiles should be the signal for an expansion of production, but that’s not happening thanks to the political uncertainty, which is damaging investor and bank confidence. Couple that with increased environmental and government approvals pressure best illustrated in the stand-off over the Adani coal project in Queensland.

Demand for coal in Asia has never been stronger, offsetting a decline in the western world. While coal critics would like to believe that falling coal prices will kill the industry, the exact opposite is happening. A lack of fresh investment, coupled with rising demand, is pushing prices up – a trend which is likely to be seen in other commodities.

Macquarie Bank is on the same page as Credit Suisse when it comes to an optimistic outlook for commodities, noting in a pre-Christmas analysis of 2019 that: “We continue to feel that the market is too pessimistic, with global growth actually strengthening, and in our view likely to come in at a still healthy 3 per cent in the year to the end of 2019”.

“Our relatively optimistic forecast for global growth does not mean that 2019 won’t be another challenging year for investors with the volatility seen in recent months continuing.

“However, for those brave enough to live dangerously, we expected risk assets to bounce back from the current oversold positions, with still good economic growth once again underpinning gains.”

A glimpse of how 2019 might unfold can be seen in the share prices of Australia’s top two miners, BHP and Rio Tinto. Both stocks had a volatile 2018 but are actually higher now than they were 12 months ago, a remarkable performance in what was supposed to have been a dreadful year for investors.

Interestingly, both BHP and Rio Tinto ended 2018 on an upswing as the market developed a greater comfort level with the disconnect between the headline political events and the underlying economy.

The iron ore divisions of BHP and Rio Tinto are useful proxies for the lack of expansion. While both are investing billion of dollars in new mines, the new assets will simply replace depleting resources, almost certainly with the benefit of lower operating costs.

Analysts at Wilsons, a Melbourne-based stockbroking firm, said in their 2019 outlook report that economic growth had not stalled, it had simply shifted “from great to good” with emerging markets likely to do well this year.

“Like a phoenix rising from the ashes, emerging markets will once again become an attractive option for investors in 2019,” Wilsons said.

The catalysts to drive emerging markets, according to Wilsons, are the same factors which will restore interest in resources: “An end to the US interest rate tightening cycle and a subsequent easing of the US dollar”.

Morgan Stanley, a US-based investment bank, said in a pre-Christmas analysis of resources that its latest assessment of commodity prices had been positive. Morgan Stanley pointed to value emerging in stocks such as Fortescue Metals, an iron ore producer, which the bank upgraded from sell to buy, without even a pause in the neutral category.

China, as it has been for the past 20 years, is the key to commodity price trends because it remains the market for up to half of the world’s traded materials. Meanwhile, Australia retains its status as a preferred supplier despite political disagreements.

Measuring Australia’s relationship with China is not easy, but there is an interesting way of doing that and it involves testing the unpopularity of other countries from a Chinese perspective. That means looking at the poor trade relationship China has with the US and an even more important development, the deterioration in the China/Brazil relationship which has followed the election of populist Brazilian president, Jair Bolsonaro, a man described as the Donald Trump of South America.

A call of the commodities card in the first weeks of 2019 looks a bit like this:

1. Gold. Still the go-to commodity/currency in volatile times and on track to crash the magic $A2000 an ounce mark in Australian dollar terms. The price is being edged up in US dollars, boosted by currency shifts. At its latest price of $A1820/oz, gold is already close to an all-time record high.
2. Iron ore, Australia’s most valuable export. While Macquarie expects its price to ease over the course of 2019 to around $US63/t for high-quality material, it should bounce back to $US71/t in early 2020.
3. Copper, the bellwether commodity. Copper is tipped to rise steady through the course of 2019 from around $US6300/t to $US6400/t, a modest upward trend but a price which will ensure reasonable profitability for most copper miners.
4. Nickel. Potentially poised for a significant rebound as it develops its role as a battery metal with the price expected to move up from $US11,750/t to $US14,500/t by the end of 2019.
5. Lithium and other battery metals. Rising supply will bear down on the price this year with the latest price for lithium carbonate of $US13,000/t likely to be almost halved over the next 12 months to around $US7000/t. It is a big but inevitable fall after the boom prices of the past two years – still high enough for leading producers to remain profitable, but not high enough to encourage new supply.
6. Coal. While a surprise to some investors, the coal price rebound has been a wonderful example of what happens when supply is squeezed at a time of reasonable demand, a trend which is likely to continue.
7. Oil. It is always slippery with an ongoing struggle between established producers who are members of the OPEC cartel (plus Russia) battling the return of the US as the world’s leading oil producer, and now a major exporter. The price is likely to remain stuck at around $US65 a barrel.

Those examples of expected prices should not cause problems for miners and oil producers. However, they are probably not high enough to act as an incentive for fresh investment.

The overall outlook for commodities in 2019 is for a rocky start as politics and trade issues dominate. Yet, once the underlying strength of the global economy is recognised as the key element the next 12 months, 2019 could turn out to be 2018 in reverse – slow start, strong finish.