Banks: 'Commodity prices will moderate'

Gone, according to two investment bank reports released this week, will be the extreme highs of the boom years that ran from 2002 to 2011, but gone too will be the extreme lows that forced mine closures, triggered corporate collapses, cost investors billions of dollars, and thousands of workers their jobs.Deutsche Bank and HSBC arrived at a similar conclusion about mineral prices in research into leading indicators of where commodities might be headed as supply tightens and demand growth remains solid.The key element in both reports is that a supply response to low prices is underway with solid demand growth expected to drive modest price rises in coming quarters.Deutsche Bank’s approach to the commodity-price question was to analyse a series of forward (or lead) indicators to estimate the likely trend in prices.From 14 potential indicator “candidates”, Deutsche settled on nine as providing a sample of sufficient size and diversity to determine that: “the super cycle is dead, long live normal cycles”.Interestingly, the normal cycles which Deutsche sees returning, will be driven by the same factors, though in a less exaggerated form, with five forces at work:The Chinese credit cycleThe Chinese property cycleGlobal fund flows and risk appetite as indicated by the U.S. dollarInflationary conditions, as indicated by the oil price, and importantlyProducer behaviour in managing supply.“Our dashboard of nine lead indicators is more positive than negative, which suggests that risks are skewed to the upside for a continuation of the current up cycle in mining equities over the next six-to-eight months,” Deutsche said.HSBC noted that current conditions clearly signaled commodity markets were “past the trough”.The London-based bank, with deep Chinese roots given its history in Hong Kong and Shanghai, said consolidation remained the focus in the mining sector.“After the heady days of the supercycle upswing, when rising prices supported profitability almost irrespective of costs, the past couple of years has seen a clear focus on cost reduction,” HSBC said.“Investment plans have been significantly curtailed and inefficient operations are starting to be closed.“This supply pullback, combined with modest growth in demand, is a key driver of the 25% lift in global commodity prices since early 2016.”HSBC acknowledges that not all commodities were behaving in the same way. Oil, for example was being effected by a market-share struggle between members of the Organisation of Petroleum Exporting Countries, and other oil producing countries, such as Russia and the US.Metals were feeling the effects of supply cuts for zinc, aluminium, nickel, thermal and coking coal.The critical question asked by HSBC was: “Are we past the trough? The bank’s answer: “Yes, the worst is over”.“Commodity prices have fallen a long way since the heady days of the super-cycle,” HSBC said. “The recent peak for global commodity prices was 2011, at levels which were 150% higher than their 1990s average level in inflation-adjusted terms.“By early 2016, the price of the global basket of traded commodities had fallen back to the low levels of the 1990s, after adjusting for inflation.“The rise in commodity prices since the beginning of 2016 has been quite broad based. Of the 50 commodities that are covered by the International Monetary Fund’s global commodity price index, two thirds of them have shown price rises since the trough in early 2016.”Deutsche’s list of nine lead indicators includes Chinese industrial production growth, the Baltic freight index (shipping), steel prices, metal inventories, and Chinese float-glass (as used in high-rise buildings) pointed to “no indications of an imminent collapse in mining equities”.Of the nine indicators, four are flashing positive, four negative, and one down – Chinese steel prices was reflecting near-term weakness. However, Deutsche does have a warning note embedded in its assessment which investors would be wise to consider: a correction from the current upswing could kick in towards the middle of next year.Using a Chinese government economic measuring tool known as Total Social Financing (TSF measures money supply, or liquidity, in the economy), Deutsche said the momentum in TSF had started to fade.“But, the lag from when the momentum turns negative to the peak in commodity or equity cycle has (traditionally) been around 10 months,” the bank said.“We think that the negative turning point will be confirmed in September’s data release (later this month).”If the latest TSF measure has turned negative then it might be a guide to commodity and equity prices moving into a slowdown around May next year, which would be in line with a conventional and modest cycle of the sort which preceded the pleasure and pain of the super-cycle.

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