The 1998 commodity review
By Rafiq Ahmed.
The strong correlation between an anaemic world economic growth and commodity price was made abundantly clear in 1998. The outright recession gripping 40% of the world's economy - from southeast Asia and Russia to parts of Latin America - has led to by far the most severe slump since the 1970s in commodity markets.
Higher inventories coupled with sluggish world-wide industrial demand had led to plunging prices. The steep deterioration in the terms of trade is hurting commodity-producing countries in Africa and other developing regions. According to a United Nations Conference on Trade and Development (UNCTAD) report, the effects of falling prices will be profoundly felt by oil-exporting developing countries such as Nigeria, Angola, Gabon, Venezuela, Iran and Kuwait which are facing declines of about 20% in their export earnings, compared with 1997. Their contraction in economic output is estimated at between 4% and 18%.
Exporters of copper and timber are also seriously affected. Export earnings of Zambia and Chile are projected to fall by around a tenth, with their nominal GDP output declining by between 2.5 and 12%. The Unctad's report blames collapsing prices of oil and other industrial commodities on recessions in Asia-Pacific, including Japan which, until mid-1997 were major importers of primary and agricultural commodities from Africa and South America.
In 1998 a series of commodity indexes provided gloomy reading for producers, but a gift for importers:
*The Commodity Research Bureau futures price index hit 21-year lows in late August;
*In August, cotton futures reached their lowest levels in 10 years
*The Economist all-items commodity price index in September plummeted by 30% since mid-1997 - its lowest level in real terms for over 25 years;
*Goldman Sachs Commodity Index fell in mid-August to its lowest level since 1977, though the index is more heavily weighted in favour of energy prices.
Base metals, in particular, are under a renewed attack from short-selling by investment funds, amid rising inventories and poor demand. The prices of most industrial materials are at their lowest in real terms since the 1930s.
Comparing with average prices in 1997, at the time of going to press, nickel was down by a staggering 40%, copper 31%, zinc 28% and aluminium 19%. Presently, base metals prices are too low to induce investment in new capacity. According to industry experts, the average price required to justify expanding copper production capacity is about $2,094 a tonne. For nickel it is $6,061, zinc $1,212 and aluminium $1,653. A sustained period of weak base metals prices will ultimately lead to significant production cuts over the next two years.
Industrial materials are dependent mainly on the construction and automobile sectors. In addition to the Asia-Pacific region, infrastructural spending in the Middle East is also declining, owing to a 30-40% plunge in oil revenues in 1998. Manufacturing output and investment in the US and Europe are less buoyant compared to 1996-97.
The copper market faces a large surplus, estimated at 400,000 tonnes in 1998. This has come about due to an increase in Russian exports and lower imports into Japan and China. Metal analysts predict an average copper price of $1,543/t in 1999.
Nickel, depressed by higher stocks - equivalent to over three months consumption and lower offtake - fell below the psychological $4,000/t level in October. Demand in the stainless steel sector, which accounts for two-thirds of nickel offtake, remains very weak. Perhaps the markets have struck bottom, since the negative fall-out from Asia and economic stagnation in Russia and Latin America are already discounted in the current low prices.
Further interest rate cuts in the US and Europe will help revive economic activity, but without a rapid resurgence in demand across Asia, which is highly improbable in 1999-2000, base metals prices will remain weak.
Gold prices slumped to a new 19-year low of 271.6/oz in late August, before recovering to the $290-$296 range from October. Even a steep US dollar depreciation and volatility in global stockmarkets have failed to uplift bullion. Investment funds are extremely bearish towards gold as a safe-haven asset. A combination of subdued inflation in major industrialised countries, selling by European central banks over the past two to three years preparing for the euro and a weakening outlook for global jewellery market explain the inexorable decline in gold price.
According to a Gold Fields Mineral Services survey, banks sold a further 260 tonnes in the first nine months of 1998, equivalent to 10% of global mine output. Few, if any, are expecting a long-term recovery. Gold may average $295/oz in 1998,down from an average of $367 between 1990 and 1997. Interestingly, gold peaked at $800 in 1980, following the invasion of Afghanistan by the former Soviet Union.
Therefore a bullion rally next year towards $320-$340 will most likely prove unsustainable given weak jewellery markets in Asia and the Middle East (which together account for over two-thirds of total gold offtake). Besides, higher bullion prices will encourage renewed bouts of selling from both official-hard/pressed central banks in Asia and Russia, as well as by private investors trying to recoup recent hefty losses on international stockmarkets.
Despite lower prices, newly mined output in Africa (which accounts for 30% of global bullion production), Australia, Latin America, Russia and Asia (which together produce 51% of mined gold) have remained steady. Because of improved efficiency, most producers are still profitable or at least are breaking even. Ashanti Goldfield Corporation currently has 7.2m ounces hedged at $391/oz over 10 years.
Platinum and palladium markets, after surging to record highs in the first-half of 1998, have now weakened following resumption of regular supplies of white metals from Russia - a major producer. Platinum at below $340/oz is at its lowest trading level for over five years. A re-shifting of the market's focus from short-term supply disruptions to demand-side fundamentals, coupled with investment fund selling, have changed white metal outlook. There is concern that lower demand for palladium in automotive and electronic industries and weak Japanese platinum imports for use in jewellery may further depress prices.
Oil prices are at a 12-year low at below $14/barrel and despite modest out put cuts (totalling under 3m barrels/day) by both OPEC and non-OPEC producers, global oil stocks rose in autumn. This indicates lower energy consumption world-wide. The IMF expects an average oil price of $13.28 a barrel in 1998 and $14.51 in 1999. This compares with $20.65 in 1996 and $19.3 in 1997.
According to the International Energy Agency (IEA), a sustained recovery in oil is only possible if petroleum demand in Asia-Pacific increases. World oil demand in 1999 is projected by the IEA to rise only 2% at best, the second-lowest rate since 1994. Oil demand world-wide rose by 550,000 barrels/day last year compared with 2m barrels/day in 1996-97.
The market is so bearish that nothing short of a miracle would uplift prices to $20 a barrel in the near future. Therefore amid weak global consumption and still ample inventory surplus, oil can only be underpinned by a severe northern hemisphere winter which would boost heating oil demand. Steep output cuts by core OPEC and non-OPEC producers (though unlikely), or major supply disruptions from Russia, Iraq and Nigeria could also be supportive of prices. The combined exports of the three producers are over 6m barrels/day.
Agricultural prices, except for sugar, have remained relatively firm this year. Conditions have been conducive to crop production and the El Nino weather pattern has had only a limited impact on 1997-98 harvests.
There is a global glut of both white and raw sugars and this will exert downward pressures on prices in 1999. London's leading trade houses, E.D & F Man and Czarnikow projects sugar output in the 1998-99 season at 128m tonnes, from 126m the previous season and consumption at 125.5m tonnes.
A bumper 1998-99 coffee harvest is also expected. The International Coffee Organisation projects global crop at 104.7m bags, up from 92.7m in 1997-98. Thus coffee futures prices are weak. Meanwhile cocoa's supply-side fundamentals are bullish and currently futures prices are trading at higher premiums. The International Cocoa Organisation projects a supply deficit of 120,000 tonnes in 1998-99 season.
Tea prices at most auction centres have fallen because of higher harvests in India, Kenya and Sri Lanka (which combined accounted for 70% of total world output - 2m tonnes - in 1998). But producer stocks and importing countries' inventories are reportedly negligible. Thus the tea market will remain sensitive to any adverse climate.
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