Rebound in commodity prices set to continue

ANALYSIS:Demand for hard assets and for raw materials saw prices bolstered unexpectedly this year, writes CAROLINE MADDEN

A COMBINATION of growing investor demand for hard assets and an increasing appetite for raw materials in emerging eastern economies saw commodity prices rebound strongly in 2010.

They rose so strongly in fact that some analysts believe the price collapse of 2008 was not the end of the multi-year commodities rally dubbed a “super-cycle”, but simply a pause.

The Reuters-Jefferies CRB index, a benchmark of commodity prices, has risen this year to over 320 points, its highest level in two years. Brian Gallagher, an analyst at Dolmen stockbrokers, says commodities such as industrial metals were outperformers in 2010, driven mainly by demand from China. He says the world’s most populous country is going through a process of urbanisation and is literally building its economy.

“They need a huge amount of resources to support this infrastructure build,” he says. “About 40 per cent of global demand for most metals can be accounted for by the Chinese economy.”

Within the industrial metals sector, copper prices surged this year to hit an all-time high of $9,267.50 a tonne in December and analysts believe the red metal’s rally has further to run. “For 2011, we like copper but not aluminium,” Gallagher says.

In a recent commodities outlook report, Credit Suisse analysts predicted copper would be among the best-performing base metals again next year.

Iron ore, used for steel, has also performed strongly, with its price rising about 40 per cent on the year to current levels of almost $170 a tonne. This rally was partly due to an iron ore export ban from India’s Karnataka State, leading to a fall in global supplies.

The rise was tempered by a mid- year slump in global steel production. Credit Suisse analysts expect prices to move higher, backed by a rebound in Chinese steel production in the first half of 2011, before slipping towards the $150 level later in the year.

Precious metals such as gold have also had a very strong year.

Gallagher explains the enormity of the sovereign difficulties facing Europe has put pressure on paper currencies, with the result investors have turned to the “quasi-currency” of gold.

After two decades of being net sellers of gold, central banks have resumed the policy of storing some of their wealth in the precious metal as a hedge. Gold has risen more than 20 per cent this year and in recent weeks has traded at all-time nominal highs of more than $1,400 an ounce.

However, when the price is adjusted for inflation it is still quite a way off the peak reached in 1980.

“Many savers concerned about their savings and the risks posed by the depreciation of the euro are diversifying into gold and silver,” says Mark O’Byrne, director of Dublin-based wealth manager and bullion broker Goldcore.

Credit Suisse believes gold prices could rise by 22 per cent next year, as uncertainty surrounding the impact of increases in the US and global money supply continue to support precious metals.

However, Gallagher is forecasting growth of just 7 to 8 per cent next year and does not see gold breaking through $1,500 an ounce. He prefers precious metals that also have significant industrial uses, such as silver, palladium and platinum.

While metal prices soared this year, the performance of energy commodities was more muted.

“The difference between energy commodities and metals is that they [energy commodities] are much more leveraged to developed world markets,” Gallagher explains. “Obviously the demand wasn’t as strong there so they [energy prices] didn’t advance much in 2010.”

Crude oil prices ticked above $80 a barrel in January and by the end of the year, it was trading above $88 a barrel. Oil markets endured two years of falling demand in 2008 and 2009 but inventories are starting to fall in developed markets and global demand is likely to remain robust.

Many analysts believe oil will remain range-bound between $70 and $90 a barrel next year. “We do not share the growing sentiment that oil prices are on an inevitable upward and sustainable journey to over $100 a barrel any time soon,” Credit Suisse said.

After falling 35 per cent this year, natural gas prices are expected to remain weak in the year ahead. Even though this winter may result in increased weather- related demand, a global glut of gas supply, partly due to new gas fields in the US, is expected to keep a lid on prices.

One of the most striking features of the 2010 commodities market was the supply loss of soft commodities such as wheat, sugar, rice, coffee and cotton due to severe weather events. This spurred surges in agricultural commodities prices.

Summer wildfires and severe droughts devastated much of Russia’s wheat harvest, leading the country to impose a rare ban on grain exports. Sugar prices moved higher after a poor crop in Brazil, while cotton prices soared to 15-year highs, due partly to floods in Pakistan, the fourth largest producer of cotton in the world.

“There are increasing risks that low-income countries will again have major difficulties in financing necessary grain imports,” the Association of European Conjecture Groups working group on commodities warned in a report. “Sharply rising prices for staple foods may even lead to another food crisis in the developing world.”

Some market commentators believe the sudden inflation is linked to the large amount of speculative money pouring into commodity derivatives markets.

Commodity prices are expected to rise again in 2011. This is good for producers, speculators and hedge funds, but bad for consumers – particularly in the world’s poorest nations.