Commodities underperformed developed market equities for the third consecutive year in 2013, following ten years of outperformance. Slowing China growth, US Fed tapering jitters and rising supply expectations have been the main factors weighing on prices. ETF Securities argues that 2014 will be a turnaround year for this laggard asset class.
Nicholas Brooks, Head of Research and Investment Strategy at ETF Securities believes that China’s adjustment from 10%-12% GDP growth rates to more sustainable 7%-8% growth rates is now largely factored into market prices.
“Prices have largely adjusted to expected increases in the supply of a number of key commodities. We think markets are underestimating developed economy central banks’ bias towards supporting growth. Healthy demand growth in the US and China, disappointments to current highly optimistic supply forecasts for a number of key commodities, and continued ample global liquidity should support commodity prices in 2014 in our view.”
“Key risks to this scenario are growth disappointments in the US or China, more aggressive than expected Fed tightening, a large negative financial event, or a stronger supply response than current consensus forecasts. While all of these risks are real and need to be monitored, on our base case scenario we are bullish broad commodity exposure, copper, lead, platinum and palladium. We believe oil prices will provide range trading opportunities and we see interesting trades developing in agriculture. We think current strong negative sentiment towards the gold price is overdone. The gold price should rally if US growth disappoints and thus it provides a good risk hedge if optimistic consensus growth forecasts prove to be wrong.”
Key commodity trends in 2014:
- Lead, copper, platinum and palladium to be the main beneficiaries of broadening global economic recovery. China’s Third Plenum reaffirmed the strong commitment of China’s policymakers to supporting growth while implementing much-needed structural reforms. Accelerated urbanisation, policies to support private sector investment, and longer-term rationalisation of uneconomic state-owned commodity production should be supportive of commodity prices. The combination of 7%+ economic growth in China, continued developed world economic recovery, and ample global liquidity should support buoyant demand for industrially-linked metals. Our top long picks are copper, lead, platinum and palladium.
- Gold and silver prices hampered by rising growth expectations, but supported by physical buying. Physical buying of gold has remained strong, but not enough to offset negative investor sentiment as tactical investors have sold aggressively as the US dollar and real interest rates have increased. As long as the US dollar continues to firm and real interest rates rise the gold price will likely remain under pressure. However, we believe that a strong physical demand reaction to lower prices similar to that seen in the first half of 2013, together with falling gold production and lower supply from gold recycling will help to limit price downside.
- Energy prices to remain range-bound, providing tactical range-trading opportunities. The dramatic increase in US shale oil and natural gas production has had a large structural impact on energy markets. The rise of US oil production has meant that global oil supply has been ample despite strong demand and reduced supplies from Libya and Iran. Although we expect oil demand to remain robust in 2014, increases in US supply will likely limit price increases. On the other hand, price declines should be limited by the ability of Saudi Arabia to cut back oil supply if prices fall sharply, and continued supply risks in Libya, Iran and Iraq should also help put a floor under prices. ETF Securities therefore expects that Brent oil prices will trade in the $100-$120/bbl range, with the WTI oil price trading at an average discount of around $10-$15/bbl. The company also expects the US Henry Hub natural gas price to trade in a $3.5-$4.5MMBtu range.
- Agriculture price performance is expected to be diverse, with corn and coffee offering potential long opportunities in 2014. Weather and other supply-side factors have been the main price drivers in 2013 and are likely to remain the key price drivers in 2014. Corn and wheat prices dropped sharply in 2013 as the US experienced record crops, the Arabica coffee price dropped to nearly a seven year low and the sugar price slumped on a supply glut. Meanwhile the cocoa price surged on poor crops in West Africa. ETF Securities will be watching for potential opportunities to go long corn in 2014 as substantial surpluses are now factored into prices and analysts forecasts. Futures positioning is extremely negative, indicating scope for a short covering rally. ETF Securities remains short sugar as we enter 2014 though this is viewed as a short-term tactical trade. Nicholas Brooks says, “it is still too early to go long Arabica coffee in our view, but we will be watching for an opportunity to go long in 2014.”
Download press release (.pdf)