A Sustainable Rally?
The beginning of 2016 was horrendous across financial markets. Pretty much everything (excluding precious metals) took an almighty hit, enabling the commentators to tell us this was the worst opening to a year for ten years, twenty years, ever – insert your own comparator. Since about mid-February, though, the carnage has been halted and prices have stabilised and indeed begun rising. The question we all want to see answered is, very simply, is that it? Has the correction happened, and are things back on an even keel?
Well, in some commodities, the recent rally has been seriously impressive. Oil and iron ore – in many ways the best indicators in recent times – have both surged, by startling percentages. But that’s a surge from very low levels; oil did indeed rally some 30-odd percent, but a move from $30 to $40 a barrel hardly signals the end of the hard times for drillers. Oil is a particular case, though, mainly because of logistics. Currently, tanker rates are sky-high, whereas dry cargo ones (which are generally accepted to be a very fair indicator of the state of world trade) are in the basement. Does that mean oil consumption is running at high levels? No, it means that the world is running out of places to store the stuff that OPEC are continuing to pump, and, unlike, say, aluminium, you can’t just store oil in a field. If the tank farms at the ports are full, or close to, ships represent the next possibility for storage. Oil is different in another way, as well. It’s not really quite a discretionary purchase; when the central heating tank is empty, you fill it, without debating whether or not the price is going to move in your favour at some date in the future. If you don’t, the house gets cold, and nobody wants that. It’s pretty much the same with filling the car with petrol. But replacing that car with another – made of steel sheet – can be delayed, although it’s true that the price rarely changes due to raw material costs; nevertheless, the dynamic of those two purchases is very different. One is (almost) unavoidable, the other can be deferred to more promising times. So if producers keep pumping and storage facilities are full, why should the price have rallied? In the end, one has to to come to the conclusion that it is technical, market factors that are responsible. So geo-political tension – particularly Middle Eastern security concerns – is a major factor, and that in a market down at historic (for ten years) lows fuelled a nervousness in the market that prompted a frenzy of short-covering. Does that suggest a real turning point? I would suggest not, once the shorts are comfortable. Russia and Saudi Arabia may have been making noises about quantity reductions, but those storage tanks are still full and those tankers are still hove to waiting for somewhere to discharge.
So if oil is subject to particular features, what about iron ore? That rallied even more, something in the order of fifty percent from mid-December lows. Well, there are a couple of things, both China-related. First, the government announced the ‘Silk Road Economic Belt’, one of the purposes of which is to absorb production (for use in infrastructure development) of Chinese steel mills, thus – probably – reducing the charges of dumping in western markets. Secondly, and probably of more immediate impact, there is a short-term emissions-based closure threat to a chunk of production, thus mills have boosted their immediate output. (On a slightly different note, when discussing oil and iron ore and their relative importance to economies, perhaps Salmond and Sturgeon may care to ponder that the Australian government’s iron ore budgetary number is $39, which happens to be about the low so far; always more sensible to go low than high, when budgeting. Makes life subsequently so much easier…)
What about base metals? Nickel has had a bit of a rally, from something around $7500 to about $9000, but it doesn’t look terribly convincing. Norilsk have made noises about producers needing to curtail production, but then, if I were the low-cost producer, I think I’d probably suggest that course to the others. Copper (with some cutbacks) and aluminium (where every cutback seems to be matched by an increase elsewhere) have both rallied from their January lows, but frankly it doesn’t look convincing.
The Great Unknown
Overlaying all this, though, is the current great unknown. What effect is increasing commodity speculation out of China having on the market? In markets which are broadly well-supplied, where there is little indication of any demand shock, that speculation is going to be the major driver. Getting the business out of China is one thing – and many are doing it quite successfully; the challenge is to try and make sense of the real direction coming from such a diverse source.
So those are the forces – the growth of commodity speculation versus the continuing stock overhang. I think for the moment, my money’s on the latter.