Commodities: Key Themes For 2014

We expect another disappointing year for commodity prices in 2014. In line with our forecasts, prices broadly undershot market consensus in 2013. The year ahead should see price consolidation, with upside limited by healthy supply, only moderate demand growth and a stronger US dollar. There is still potential for volatility in certain markets, particularly where significant government policy has the potential to radically impact supply or demand. Below we highlight our key commodity price themes for 2014:

  • Soft commodities to outperform

  • Iron ore and copper to underperform

  • Commodities will continue to underperform equity markets

  • Limited inflation pressures from commodities

  • Heightened policy risks to supply and demand

1. Soft Commodities To Outperform

After three years of steady declines, we think the S&P GSCI softs index has formed a base and will head modestly higher in 2014. This should see the softs index outperform other indices, particularly the energy and metal segments. We forecast higher prices over the year for cocoa, palm oil, sugar and coffee. Mixed production prospects underpin our positive view on these commodities, as significantly lower prices in recent quarters have undermined crop investment. This is particularly the case for cocoa, for which we forecast prices to average 18.9% higher in 2014 than in 2013 at GBP1,850/tonne. We see the cocoa market entering a period of sustained global deficits brought on in part by accelerating demand growth, but more importantly due to a lack of investment in West Africa's cocoa sector that will limit production growth.

Softs To Outperform
Select Commodities - BMI 2014 Average Price Forecast vs Spot Price, % Difference

We expect another disappointing year for commodity prices in 2014. In line with our forecasts, prices broadly undershot market consensus in 2013. The year ahead should see price consolidation, with upside limited by healthy supply, only moderate demand growth and a stronger US dollar. There is still potential for volatility in certain markets, particularly where significant government policy has the potential to radically impact supply or demand. Below we highlight our key commodity price themes for 2014:

  • Soft commodities to outperform

  • Iron ore and copper to underperform

  • Commodities will continue to underperform equity markets

  • Limited inflation pressures from commodities

  • Heightened policy risks to supply and demand

Softs To Outperform
Select Commodities - BMI 2014 Average Price Forecast vs Spot Price, % Difference

1. Soft Commodities To Outperform

After three years of steady declines, we think the S&P GSCI softs index has formed a base and will head modestly higher in 2014. This should see the softs index outperform other indices, particularly the energy and metal segments. We forecast higher prices over the year for cocoa, palm oil, sugar and coffee. Mixed production prospects underpin our positive view on these commodities, as significantly lower prices in recent quarters have undermined crop investment. This is particularly the case for cocoa, for which we forecast prices to average 18.9% higher in 2014 than in 2013 at GBP1,850/tonne. We see the cocoa market entering a period of sustained global deficits brought on in part by accelerating demand growth, but more importantly due to a lack of investment in West Africa's cocoa sector that will limit production growth.

No Return To Uptrend
Reuters Jeffries CRB Commodities Price Index

We are not getting carried away with bullish prospects for softs, as most markets will remain relatively well supplied. Our view for the Brazilian real to weaken further over the course of 2014 (averaging BRL2.30/US$ compared to BRL2.16/US$ in 2013) also plays an important role in tempering our upside price forecasts for coffee and sugar. Brazilian exports play a dominant role in these markets and thus international prices are historically negatively affected by real weakness. We expect local currency weakness to bolster Brazilian producer returns and result in more positive production than would otherwise have been the case in 2014.

2. Iron Ore And Copper To Underperform

We forecast lower prices for key industrial commodities such as copper and iron ore in 2014. Metal prices enjoyed a moderate bounce in H213 on account of a Chinese led upswing in global demand. We expect supportive factors to fade in the coming quarters and result in lower prices. While this will impact industrial commodities broadly, we expect iron ore and copper to be most negatively affected for reasons discussed below.

Healthy Supply Growth Ahead
Selected Commodities - Global Mine Production, % Chg y-o-y

On the demand side, our relatively downbeat view on China's medium-term growth prospects is central to our below consensus metal price forecasts for 2014. Although China's economy is still feeling the upswing from stimulus efforts and we have revised up our real GDP growth for 2014 from 6.7% to 7.1%, we do not expect this resilience to last. Our 2014 real GDP growth forecast remains below the consensus estimate of 7.5% and we expect the hangover effects from China's credit boom to resurface by mid-2014.

More Bearish Than Consensus For Industrial Metals
Select Commodities - BMI 2014 Average Price Forecasts vs Bloomberg Consensus, % Difference

Copper and iron ore will be most exposed to slower Chinese demand growth for two reasons. First, we expect a marked slowdown in fixed asset investment to be at the centre of China's economic slowdown. Demand growth for commodities intensively used in the construction industry such as iron ore, used for steel, and copper will thus suffer. Second, China dominates the seaborne markets for these commodities, accounting for 65% and 42% of global iron ore and copper imports in 2012, respectively. That said, other industrial metal markets will also be significantly affected. Although we forecast a stabilisation in the prices of other base metals such as nickel and zinc and target gains for lead and tin, our price forecasts generally remain below Bloomberg consensus.

Construction: From Driver To Drag
China - Selected Economic Indicators & Steel Consumption

Turning to supply, both iron ore and copper are steadily transitioning from deficit to surplus markets. The prices for both commodities soared to record highs in 2011 as supply failed to keep up with rampant demand growth. By early 2011, copper and iron ore prices had roughly doubled from their January 2005 levels. However, mine supply is now at the start of a multi-year surge as the high prices of recent years have incentivised mammoth investments that are now beginning to come online. From the Oyu Tolgoi copper mine in Mongolia to the iron ore deposits of Pilbara, Australia, large-scale mine expansions will ensure ample copper and iron ore mine supply growth in the coming quarters. Although disappointing mineral prices will result in scaling back of current mining capital expenditure plans ( see 'Top Firms Signal Continued Capex Weakness', December 4), we still anticipate healthy supply growth.

Iron Ore & Copper Exposed To China
Select Commodities - China Imports, 2012 (As % of global volume)

3. Commodities Will Continue To Underperform Equities

We expect commodity prices to continue underperforming developed equity markets over the coming quarters. Although a repeat of the almost 20% rise in the MSCI World index in 2013 (year-to-date) is unlikely, we remain bullish developed equity markets in 2014. In contrast, commodity indices should be anchored by subdued oil prices and declines for major metals. Due to China's dominant role as a commodity importer, commodity prices will be disproportionately affected by the disappointing economic growth we forecast for the country over 2013 and 2014. Bumper production growth of major commodities including oil and metals will also drag on price performance.

Commodities To Continue Underperforming
Ratio Of MSCI World Equity Index To CRB Commodities Index

In contrast, developed market equities will be underpinned by further US economic resilience. According to Citi research, institutional and retail commodities assets under management in Q313 were 20% lower year-on-year and down a third from their 2011 peak. While the outflow of speculative money from commodities markets could slow, the trend will remain in contrast to continued equity market inflows. In line with the view we first promoted back in March 2012 ( see 'Commodities Outlook, April 2012', March 27, 2012), equities have continued to outperform commodities, as illustrated by a rise in the ratio of the MSCI World Index to the CRB Commodity Index.

4. Limited Inflation Pressures From Commodities

The broad impact of commodity prices on inflation should remain neutral-to-negative in 2014. Energy prices will have the most positive impact on headline inflation globally, as lower oil prices (with the exception of WTI) will be partially offset by modestly higher thermal coal prices. Nonetheless, we expect year-on-year comparisons in energy prices to remain subdued. Ample spare OPEC capacity should limit the risk of a spike in oil prices in the event of supply disruption.

Food Price Inflation To Remain Muted
Select UN Global Price Indices, % Change y-o-y

Food prices will be kept in check by strong global grain crops in the ongoing 2013/14 season. For instance, corn prices will be anchored by the hangover effects of the recently harvested 2013/14 US corn crop, which was the largest ever recorded. The year-on-year change in UN food price indices has turned sharply negative in recent months and this is bound to normalise in 2014 due to lower base effects. Nonetheless, food price inflation should remain a minor concern.

5. Heightened Policy Risks

2014 has the potential to provide surprises in the form of government or regulatory policy that could radically impact underlying commodity supply and demand fundamentals. While commodity markets are typically vulnerable to supply shocks and we name some potential pinch points below, there are also several cases where policy change could significantly loosen markets and drag on prices in the coming quarters.

Downside Price Risks

Aluminium - LME reform has the potential to significantly improve the availability of aluminium to end users and place downward pressure on prices. Due to the opaqueness of the metals warehousing system and the lack of clarity of how agreed reform will impact the market, we are currently sticking to our expectation for aluminium prices to base around the US$1,800/tonne area in 2014. However, we note significant downside risks to this forecast.

Cotton - China's market distorting cotton stockpiling policy, which has proven counter-productive, is on the verge of a reform. The government is now eager to release its colossal stocks to limit imports and is considering abandoning the procurement prices, which have maintained domestic prices almost twice as high as international cotton prices over the past two years. An abandonment of the stockpiling policy next season or the release of stocks at a lower price will free up previously insulated supply and send international cotton prices lower. China could also revamp its stockpiling policy for other commodities, including corn and sugar, in the coming years, which could also put downside pressure on international prices.

Rice - Risks are growing that Thailand will be forced to dump the hefty rice stocks accumulated by the ongoing 'Rice Pledging Programme' on the international market at a significant loss. Indeed, political and economic pressure is mounting against these much criticised subsidies. An abandonment of the policy next year or a pickup in Thai rice exports at a depressed price could send international rice prices significantly lower ( see 'Rough Rice To Average US$13.50/cwt In 2014', October 15).

Surplus Faces OPEC Risks
Oil Production, Consumption & Price Forecasts

Upside Price Risks

Nickel - Indonesia's export ban on unprocessed ore, set to come into effect in January 2014, presents an upside risk to nickel prices. We believe the Indonesian government will eventually back down and choose to impose higher export taxes rather than implement a full ban. While higher taxes would certainly raise ore prices and reduce Indonesian shipments, such a result would not drastically tighten the global refined nickel market. However, should export restrictions be more stringent than we currently expect, prices could fair far stronger in 2014 than we currently anticipate. We forecast nickel to average US$14,750/tonne in 2014, a modest 4.6% increase from the spot price at the time of writing. Nickel is particularly exposed to any restrictions on unprocessed ore exports given the dominance of Indonesian shipments on the international market. The country accounted for 67.5% of global nickel ore exports in 2012. Turning to other commodities, bauxite would also be heavily exposed given that in 2012 Indonesia provided 59% of imports into China, the world's largest aluminium producer.

Oil - We see growing risk of a material cut to OPEC production in 2014, with resulting upside risks to prices. Saudi Arabia has signalled that any necessary curtailment of production by OPEC would have to come in a coordinated move. While we have already assumed a slight reduction (of around 1%) in Saudi supplies for 2014, we will be watching these developments closely and may revise our production forecasts further downward should events justify it.

Select Commodities - Performance & BMI Forecasts
Commodity Unit Spot Price YTD (% Chg) 1 Year (% Chg) 2012 (ave) YTD (ave) 2014 (BMI ave) 2015 (BMI ave)
Aluminium US$/tonne 1,794 -13.5 -15.5 2,052 1,891 1,900 2,000
Barley EUR/tonne 207 -23.2 -22.7 250 227 225 215
Brent Crude US$/bbl 110 -0.6 1.2 112 109 103 102
Class 3 Milk US$/cwt 18.1 -1.2 -0.8 17.59 18.05 16.00 15.50
Coal, Thermal (Newcastle) US$/tonne 85.7 -8.6 -8.6 96.8 85.3 87 93
Cocoa (London) GBP/tonne 1,784 24.3 15.5 1,540 1,569 1,850 2,000
Coffee USc/lb 115 -20.2 -16.5 175 126 120 130
Copper US$/tonne 7,290 -8.1 -9.6 7,953 7,352 6,800 6,750
Corn USc/bushel 423 -39.4 -41.1 695 584 425 425
Cotton USc/lb 83.3 10.8 10.9 79.7 83.4 89.0 85.5
Gold US$/oz 1,244 -25.7 -26.6 1,669 1,417 1,250 1,150
Iron Ore US$/tonne 135 -6.9 4.3 128 135 110 100
Lead US$/tonne 2,166 -7.0 -5.6 2,074 2,153 2,250 2,300
Natural Gas US$/MMBtu 4.26 27.2 28.6 2.83 3.70 4.05 4.5
Nickel US$/tonne 14,030 -17.8 -21.5 17,591 15,114 15,000 15,500
Palladium US$/oz 716 1.8 2.2 645 727 na na
Palm Oil MYR/tonne 2,541 9.5 21.0 2,901 2,398 2,650 2,700
Platinum US$/oz 1,361 -11.6 -15.7 1,553 1,492 na na
Rough Rice US$/cwt 15.55 15.4 8.2 14.86 15.47 13.50 12.80
Silver US$/oz 20.04 -33.6 -37.8 31.15 23.93 na na
Soy Oil USc/lb 39.8 -19.1 -19.9 52.2 46.1 na na
Soybean USc/bushel 1,338 -5.7 -10.6 1,466 1,410 1,300 1,375
Steel (MEPS Carbon Steel) US$/tonne 710 -1.5 -0.1 755 707 695 690
Sugar #11 USc/lb 16.27 -16.6 -14.4 21.57 17.53 18.00 18.50
Tin US$/tonne 22,775 -2.7 -1.6 21,100 22,279 22,500 23,000
Wheat USc/bushel 622 -20.1 -22.4 751 687 610 625
WTI Crude US$/bbl 97.4 6.1 12.3 94.1 98.0 101.5 101.0
Zinc US$/tonne 1,992 -4.2 -4.7 1,965 1,935 1,950 2,050

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