Bulk buying

News was prepared under the information support of Online Daily Newspaper on Hellenic and international Shipping "Hellenic Shipping News".

31 Jan 2010

Demand for commodities rocketed as prices fell and investors sought hard assets as a currency and inflation hedge. But what is the short-term outlook for the sector? Some say it is hot while others argue that it is overheated. Muriel Oatham reports.
The mining industry roared back into life in 2009 as commodities boomed. The International Monetary Fund (IMF) commodity price index rose by 40% between February and October, and the Association of Investment Companies (AIC) declared commodities and natural resources the year’s best performing closed-ended sector, with growth of 82%.
“We saw a surge in industrial metals, led by copper, and in precious metals, and oil prices doubled,” says Nicholas Brooks, the head of research and investment strategy at ETF Securities.
But commodity fund managers agree that they witnessed a far from typical recovery.
“In 2008, as the global economy shrank, there was a huge pull-back in demand, and commodity prices fell,” says Richard Davis, manager of the BlackRock Commodities Income investment trust. “But the strong recovery in 2009 was not really driven by an uplift in global demand. (article continues below)
“We saw record imports into China, as it took advantage of low prices to build inventory stocks. The dollar was weak, and as investors’ appetite for risk increased, they bought into ­commodities.”
 ”This year is much more about understanding individual commodity markets, rather than playing the overall macro trend”
Investor demand was strong. In 2009, says Brooks, assets in exchange traded commodities (ETCs) more than doubled, reaching $16 billion (£9.8 billion), compared with $7 billion at the end of 2008. “There was a flood of inflows from strategic investors, seeking a hedge against currency debasement and the risk of inflation,” he says.
David Donora, the head of commodities at Threadneedle, agrees that extraordinary economic conditions led managers to take overweight positions in commodities. “Quantitative easing and zero interest rates drove managers, seeking a store of value, to invest in hard assets.”
This trend shows little immediate sign of slowing. January’s Bank of America-Merrill Lynch survey of European fund managers showed a 23% net overweight in commodities for the third consecutive month, close to an all-time high.
But commodity specialists say a more difficult year lies ahead, while economic commentators are divided. The IMF expects demand growth to continue to drive commodity prices upwards, but the World Bank is more pessimistic, predicting that a slow global recovery will restrict average price rises to just 3% per year in 2010 and 2011.
Davis shares the cautious view. “Global demand is still weak. Record buying from China will tail off to a normalised level, and restocking from the western economies has not yet begun.”
And Brooks is anticipating tougher trading conditions in 2010. “A lot of good news has already been priced in [to the market]. We will see greater uncertainty, which will lead to increased price volatility.”
But Donora is more optimistic. “We will not see the very strong price moves of 2009, but prices will continue to trend higher throughout 2010.” He says growth will be sustained by a combination of low interest rates, demand from emerging markets and supply constraints in specific commodities.
George Cheveley, the joint-portfolio manager of the Investec Enhanced ­Natural Resources fund, says the key market concern this year is not price, but diversification.
“Commodities represent a huge number of different assets with their own fundamentals and characteristics. Over the last two years it has been easy [for investors] to forget that. But in 2010, we will see very wide disparity in performance,” he says.
”Contract prices of iron ore could rise by 30% or so”
Donora agrees. “This year is much more about understanding individual commodity markets rather than playing the overall macro trend,” he says.
Cheveley says that base metals - copper, aluminium, zinc and nickel - could have a difficult year. “While we have seen demand accelerate and prices rise, these may have got overbought in the short term. Zinc, in particular, we think has grown too far too fast,” he says.
Myles Campion, director and fund manager at Oceanic Asset Management, says nickel is overvalued, and is anticipating a price correction. “Nickel stockpiles at the London Metal Exchange are at their highest since 1994. But then it was trading at $3 per pound, not $8.50,” he says.
Brooks says he is wary of industrial metals. “Inventories have risen, and will continue to do so. And there is little near-term fundamental support for this market, making [these metals] very vulnerable.”
Davis says aluminium will underperform. “Demand for aluminium has been poor. But its production is power intensive, and falling energy prices meant that producers were disinclined to turn off supply. So we now have a substantial inventory overhang, and prices will not move until this has cleared.”
Cheveley and Campion say that bulk commodities - iron ore, thermal coal and coking coal - offer more sustainable growth prospects. “We are anticipating price increases of 20-30%,” says Campion.
“There is good momentum in this market,” says Cheveley. “Contract prices of iron ore could rise by 30% or so.”
And managers are universally bullish on the prospects for platinum and palladium. The recovery in motor manufacturing has reignited demand, while supply is constrained, partly by cost, meaning prices are likely to be driven upwards.
“Platinum has huge supply issues,” says Cheveley. “Seventy percent of ­production is in South Africa, where power and labour costs [of mining] are rising by 10-12% per annum. It is very hard for the mines to grow.”
Campion warns that a seemingly unrelated event could have a direct impact on this market.
“Platinum production is very power-intensive. And South Africa has seen a huge increase in power consumption in the last 10 years without growing capacity, which creates supply risks.
“When South Africa hosts the World Cup in June, it will want to ­guarantee power supplies to the tournament. So we could see the smelters shut down, creating a short-term price spike.”
While the immediate market outlook is volatile, Davis says that the market dynamics of supply and demand mean the sector as a whole is on a long-term upward trend.
“In the bull market of 2000-07, demand far outstripped supply. And supply growth today is even weaker than in 2000-07. Companies are not building new supply.”
Frances Hudson, a global thematic strategist at Standard Life Investments, says: “During the financial crisis, a lot of big metal companies cut back their capital expenditure, And with long lead times in metal production, bottlenecks and shortages can arise quite quickly.”
But Davis says it is not simply a matter of re-injecting investment. “In some sectors it is simply difficult to grow production. 2007 was a bumper year of exploration expenditure for mining companies, but that did not mean they uncovered significant new stock.
During the past year, China has led demand for commodities. While ­managers dismiss the suggestion that commodity investment is simply another play on Chinese or wider emerging market growth, they do not doubt the strength of its influence.
“The massive bounceback in 2009 was largely down to China spending its huge economic stimulus on proper infrastructure investment,” says Cheveley. “In metals, China accounted for 43% of global demand.”
Campion says that the emergence of China as a force for resource demand has reshaped the commodity market.
He says China will continue to dominate the market for the next five to 10 years. “China cannot turn off overnight. Even if Chinese growth was to be flat for the next three years, the fundamental dynamics [of the commodity market] have changed.”
“If you invest in hard commodities, you have to believe in China,” says Davis. “It is now the biggest consumer of all commodities except oil. And it is a young, growing economy. This means China’s consumption per capita is low compared to the West. So as its economy grows, so will its intensity of use.”
While Donora acknowledges the potential of emerging markets to drive demand for commodities, he warns against overly optimistic forecasts. “We have to be careful not to overlay western consumption models on to emerging markets,” he says.
Davis tips India as the next significant commodity buyer. “The Indian economy is about 10 years behind China. But with another one billion-plus population, India will become a huge user of commodities.”
Campion is more cautious. “India has not really fired, partly due to its bureaucracy and the fact that it is a democracy. It has a similar sized ­population to China, but not the central control.”
Hudson agrees that emerging markets will sustain demand. “As long as they remain focused on building infrastructure, rather than developing their service industries, there will be a strong link to commodities.”
But she warns that China’s dominance in some markets could cause complications. “Last year, we saw big materials companies forced to reduce iron ore prices. They will want to raise them this year, but China will resist this. While China’s steel demand is sustained - and it does not yet have enough steel capacity to re-process scrap - it needs iron ore. So maybe the iron ore producers will win. But we could see increased volatility in that market.”
And Hudson identifies a further potential political risk. “In 2009, China tried to secure monopolistic access to some rare minerals, buying up African companies to ensure its supply. If this continues, we could see protectionist behaviour start to emerge.”
With the major economies emerging from recession, inventory restocking by the developed world is expected to provide further stimulus to commodity markets.
“The economic recovery in the West, in America and the eurozone, is the swing factor this year,” says Cheveley. “We will see a fallback if these economies do not return to growth.”
But while global recovery may drive commodity prices higher, there is a risk that signs of overheating in the sector could serve to hamper growth.
“If commodity prices go too far too fast, they could stifle recovery,” says Donora. “We saw that with oil hitting $140 per barrel.”
However, he says a return to that scenario is unlikely. “Opec [Organization of the Petroleum Exporting Countries] will bring on spare capacity if the oil price gets above $85 per barrel. They will not want to jeopardise global economic stability. And if it falls below $60, they will use supply control to prop up prices.”
“Oil prices at over $100 a barrel will damage the American economy more than others, and that is the economy we need to recover,” says Cheveley.
That prices will remain range-bound, trading between $60 and $80 a barrel, is a widely held view, meaning managers are pessimistic on oil.
“We are very cautious. Supply is strong, with global oil inventories at historically high levels,” says Vadim Mitroshin, oil and gas analyst at Otkritie, a Russian brokerage. “Opec spare capacity more than covers anticipated demand, even if the global economic recovery is quicker and faster than expected.”
With growth coming from such a depressed base, there could be huge demand for commodities to rebuild”
While Mitroshin argues that the sector is attractively priced for the longer term, he says oil market conditions will be tested this year. “The risk remains on the downside, and I am not ruling out a fall in prices,” he says.
“There is an enormous amount of floating inventory from the carry trade. If market conditions change, we could see 150m barrels of oil hit the market in a relatively short time.”
In the energy sector, Mitroshin is more positive on the outlook for natural gas, where he says valuations remain attractive. Countries looking to reduce emissions by using cleaner fuel are expected to drive demand for natural gas. “Capacity is good, and we will see increased production of liquid natural gas [LNG] in the next few years,” says Mitroshin.
Donora agrees. “Improvements in technology mean natural gas can be accessed at a more economic price and gets from the ground to market faster. Supply is increasing but demand will be sustained, so prices will remain competitive.”
Others are less optimistic. “A fall in demand in America has led to huge oversupply in LNG, and market fundamentals are not very good,” says Davis. “The price of LNG in America today is below the marginal cost of production. It is unlikely to stay that way, but could drift lower in the short term,”
Brooks says fundamental differences between oil and gas will cause continued divergence in energy prices.
“Oil can be easily shipped and traded internationally, while natural gas is difficult to transport and to store, meaning the market is more strongly affected by domestic demand,” he says.
The energy market has also attracted regulatory attention. Last month, the US Commodity Futures Trading Commission (CFTC) unveiled proposals to restrict speculation in oil and gas markets. But the impact on the market is expected to be low, with proposed position limits set so high they are only expected to affect up to 10 traders. However, the potential for similar legislation to cover gold, silver and copper is already being discussed.
Davis dismisses the impact of speculation on the commodities market. “There are no futures markets in iron ore or coal, therefore no outside influence. And their prices performed even better than some of the exchange-traded commodities,” he says.
“Many people thought the bull market of 2000-07 was due purely to speculation, but that was simply not the case. While investment does increase the volatility of commodity price movements, the fundamental trend remains one of supply and demand.”
Vladimir Savov, the head of research at Otkritie, says greater caution from investors will dampen the likelihood of speculation.
“We cannot tell where real growth stops and bubbles start, so people could be speculating on top of real demand. But the speculative element of the market was much bigger in 2007-08. Investors are much more risk averse today.”
But managers are confident that investors’ appetite for commodities, and influence on the market, will be sustained. “The market has to get used to investor demand,” says Cheveley. “Ten years ago, there was very little commodity investment. But as interest has increased, so have the ways investors can get involved in the market.”
Cheveley says investment has hit demand in some cases. “The new physically-backed ETCs in New York have driven prices up sharply. These can soak up a lot of demand and have a big effect in a small market, such as platinum.”
Donora says commo­dity investors are growing to appreciate the need for active management. “Last year, spot prices rose by over 50% while indices were up about 15%. So while ETFs and passive funds have done well, they underperformed in terms of what could have been achieved.”
But Hudson is more cautious. “Flows into commodity ETFs and indexed products are predominantly from retail investors looking for diversification. But commodities are still risky. They carry no income, but are vulnerable to roll costs, so investors could see their capital dwindle if prices fall.”
Hudson says that, as a retail investor, she prefers commodity exposure via equities, through mining stocks such as BHP Billiton. “Commodities were a major driver of British equity performance last year, with the materials sector up by over 100%.”
While opinions differ widely, this diversity within the commodities market is likely to sustain investor interest. Commodities offer the potential to seek long-term growth or play short-term price volatility, to gain exposure to emerging markets or western economic recovery, and can be held via equities, passive funds or physical assets. World Cup fears aside, it looks unlikely that the mines will be turned off during 2010.

Source: Fund Strategy