Bullish outlook for commodities this year
T
his morning’s results presentation by mining and trading giant Glencore gave a bullish outlook for commodity prices in 2017 supported by quoting “supply side risks”. I thought it would be worth mentioning some of the key factors that will contribute towards sustaining higher prices:
- Supply side stresses
- Improvement in commodity fundamentals
- Reduction in sector investment
Supply side stresses
Voluntary supply cutbacks — As we have seen in the iron ore market, Rio Tinto and BHP Billiton have made supply cutbacks in an effort to drive up prices. And it worked. It is expected that miners may continue to follow this strategy in order to ensure stockpiles at warehouses are kept at a minimum.
Involuntary supply cutbacks — With strikes (e.g. in Chile, South Africa) and technical issues (e.g. export cutbacks and mining licenses in Indonesia, environmental regulation in China and in the Philippines) we can expect this to play its part.
Chinese supply side structural reforms — Deleveraging, reducing supply and destocking, lower costs, technological innovation, quality improvement. This is not an exhaustive list and also tends to apply to many industries e.g. agriculture. Regulation is again also important here as China can influence the market very quickly with regulation (e.g. reducing the number of working days).
High grading to enhance cash flows — By producing the highest grade ores that have decent quality grade of the material being mined, higher prices and therefore higher cash flows can be commanded.
Improvement in commodity fundamentals
Better than expected demand and inventory — And we predominantly look to China as the biggest consumer of commodities (at least on the metals side) as a force behind driving up commodity prices. Inventory is also a key factor, as the lower the inventory that is kept in warehouses, be they LME or private, one can expect this to support higher prices.
Reduction in sector investment
Capex for the main miners has fallen from around USD 75bn in 2012 to USD 25 bn in 2016. Across the industry, there are no real major plans to build significant mines and this trend is expected to continue. It is expected that an increase in Tier 2 and 3 assets will also lead to a fall in production. In addition, with aging mines, low quality ores, lack of proper infrastructure, water, energy shortages as well as a social license to operate are also important factors. The relationship between low prices and exploration activity and or new mines is a positive correlation.
There are of course other aspects which we need to consider such as the strength of the dollar or interest rates however when you look at more direct ways to sustain higher prices, the above actions cover plenty of it. Generally it seems as though, if miners can bear the impact of reducing supply in a bid push up prices we can look forward to a commodity resurgence this year (at least).
