Commodities posted positive returns for the first time in six years in 2016, with almost everything from silver to iron ore to soybeans ending up in the black.
But there are looming questions about whether that performance, driven in many cases by tight supply conditions resulting from a half-decade funk, can be repeated in 2017.
As a group, commodities will likely finish 2016 up 25 per cent, according to Scotiabank’s Commodity Price Index. That compares to a 30 per cent decline in 2015.
Analysts and strategists believe that overall positive trend will continue into 2017 — although some of the biggest outperformers, such as coal and iron ore, are unlikely to match their gains.
“At this point it feels the market is very confident we’re going to see improved economic growth next year — that’s what’s getting priced in,” said BMO commodity analyst Jessica Fung.
But as we move along the U-shaped recovery, uncertainty persists: The big question is whether the fundamentals in 2017 will prove to support the optimism over commodities’ new direction, she said.
“The commodities that really outperformed in 2016 were driven by supply side issues,” Fung said, citing a 300 per cent rise in metallurgical coal, a 60 per cent jump in zinc and a 63 per cent increase in natural gas futures contracts.
“Going into 2017 it’s still a supply story — whether it’s driven by policy or by mining companies deciding to take some production off — that’s what will move the price.”
But demand is also improving along with the outlook in the world’s biggest economies, added David Wilson, director of metals research and strategy at Citi.
The U.S. is not the only country ramping up for a large-scale infrastructure program. Canada, Japan and European countries, as well as China, have also announced infrastructure plans, which should bode well for base metals and energy.
“Demand has been much much better than expected and that’s probably the argument across most metals, whether you look at aluminium or iron ore or steel production or what have you,” Wilson said.
The commodities story in 2016 was not fluid; instead, it was a year with several different chapters, Fung said.
During the first half of the year, gains for precious metals, such as gold and silver, were the major narrative.
Gold had the best first half of the year since 1979, fuelled by heightened global uncertainty and June’s Brexit vote.
But the safe haven asset made an about face when Donald Trump was elected and has since dropped by more than 10 per cent to end the year near US$1,150 an ounce.
It is expected to remain in the doldrums well into 2017.
In the second quarter, iron ore, metallurgical coal and steel took off. Met coal was the standout and was up some 300 per cent this year — largely because of China’s decision to restrict production.
And by the fourth quarter, copper, which had been on track to be one of the worst performers, began a tear to close the year some 30 per cent higher on higher hopes for demand of the metal on U.S. president-elect Donald Trump’s infrastructure promises.
While the story for some commodities, specifically gold and copper, seemed to flip during a single night in the final quarter of the year — the U.S. election on Nov. 8. — the story, as usual, had more to do with China, Wilson said.
China’s economy performed better than expected in 2016 and its outsized influence on commodities was evidenced in its efforts to reduce excess capacity in coal and steel — sending prices of those commodities through the roof and contributing to higher natural gas prices as well.
“I know the U.S. likes to take credit for most things, but they can’t really take credit for the commodities rally,” Wilson said.
Commodities traders got more optimistic on the global economic outlook in December after the Federal Reserve decided to raise interest rates for the first time in 2016 and indicated it would likely do so multiple more times in 2017.
“Right now the market is quite optimistic — this is no different than the honeymoon periods on equities in risk-on environments,” said Bart Melek, head of commodity strategy at TD Securities. “But reality will ultimately kick in.”
That sense of optimism is why gold has lost some of its appeal and why copper prices have taken off recently. But that could change.
Most commodities, including oil, copper, nickel and zinc are expected to run ahead on improved sentiment about the economy.
Still, Fung cautioned, there is much political uncertainty in the year ahead.
“What if Europe goes into election mode and all of a sudden everyone is concerned about populism again? What if everyone starts talking about Brexit and what that’s going to mean? What if the infrastructure and all these tax rebates that Trump’s talking about doesn’t actually get the consumer up and spending again?” she asked.
“The risk, really, is: What if we stumble? What if we hiccup?”
Source: Financial PostPrevious Next