Nov 21 2012

End of commodity supercycle?

End of commodity supercycle?
Gold is mirroring a larger bout of investor disenchantment with commodities. The current trend could signal the end of the commodity supercycle, warns Citibank.
Investors appear to be losing faith in the bull story for gold, says Ed Morse, Citibank's star analyst.

"Indeed, net long managed money positions on Comex have fallen by 33% since October 2 2012, not exactly a vote of confidence for further significant gold upside," the renowned analyst said in a note to clients. "Perhaps only more concerted European policy moves with reference to managing Greece/Spain may provide Euro confidence, and thus gold upside."

Gold is mirroring a larger bout of investor disenchantment with commodities.

"Seeking alpha in commodities in the years ahead poses challenges, as it is now clear that the commodity supercycle is over," says Mr. Morse. "No longer will a pure long-only strategy bring the returns expected in 2002-2008. Nor will conditions approximating those of the last decade return any time soon."

Decomposition of real commodity prices suggests four super-cycles during 1865-2009 ranging be­tween 30-40 years with amplitudes 20-40 percent higher or lower than the long-run trend, say Bilge Erten, an associate economic officer at the United Nations and José Antonio Ocampo, professor at Columbia University.

"Non-oil price super-cycles follow world GDP, indicating they are essentially demand-determined; causality runs in the opposite direction for oil prices.... Tropical agriculture experienced the strongest and steepest long-term downward trend through the twentieth century, followed by non-tropical agriculture and metals, while real oil prices experienced a long-term upward trend, interrupted temporarily during the twentieth century."

Analysts have identified a massive commodity boom in the past decade, which ushers the fourth commodity supercycle over the past 100 years.

The global economic crisis was 2008 preceded by a commodity price boom that was unprecedented in its magnitude and duration. The real prices of energy and metals more than doubled in five years from 2003 to 2008, while the real price of food commodities increased 75%.

The current commodity supercycle is driven by insatiable demand by emerging market for a whole host of commodities such as alumnium, oil, gold and silver, global growth has dampened sentiment.

But growth seems to have subsided since the global financial crisis.

Central banks across the world have taken a proactive approach to stimulate their economies, but while they have avoided recession, they have not been able to trigger robust growth.

The IMF gauges that there is a 1-in-6 chance that global growth could fall below 2%, which would feature widespread recession in advanced economies and roughly marks the "tipping point" before economic behaviour, including commodity demand, changes structurally, the bank notes.

Citi's sentiment echoes that of Morgan Stanley analyst says Ruchir Sharma who earlier suggested commodity growth is subsiding.

"China's growth is downshifting to a lower plain, its very commodity-intensive phase of growth is coming to an end. This to me marks a big decade of increase in commodity prices coming to an end," Sharma told CNBC.

"I suspect that we're headed now for two decades down as far as commodity prices are concerned. This is the sunset of the big commodities super-cycle," he said.

Not everybody agrees with this prognosis, of course.

Jason Grantham, veteran co-founder of GMO Capital and a well-known commodity bull believes that commodities and commodity-producing stocks will continue to outperform.

"If the price trend of commodities continues upward, which I believe is nearly certain, then commodity company profits and their stock performance will continue to outperform as they have magnificently since the game changed in 2002," the analyst said in a November note.

"I'm a great believer that the supercycle has more to go," said Richard Elman, chairman and executive director of Hong Kong-based commodity investor Noble Group Ltd at a recent investment conference. "Next year is going to be a tough year. Global growth is struggling. I wouldn't be overly bullish on a six- to nine-month view."

Marc Faber, the legendary market guru, says while investors should go long on gold and silver, he remains unconvinced by the growth prospects of other commodities - arguing that prices have peaked.

True, investors can see their holdings stagnant as they gaze at their portfolio.

While Citibank's Mr. Morse believes there is still money to be made, and commodities still have head room to grow, the supercycle aspect of growth may be a thing of the past.

"A global rebound in commodities demand is anticipated, perhaps by the end of 2013, given all of the policy stimuli packages that are being implemented," says Mr. Morse. "Some markets will tighten more quickly than others, but as demand rebounds along with global growth, commodity prices are unlikely to move sharply higher."

Here is Citibank's forecast for key commodities:

GOLD: With Indian and Chinese demand waning, gold will need a couple of catalysts to rally in the new year: Either a major geo-political event or a greater confidence in the Euro zone to be able to manage the ongoing debt crisis, more importantly in Spain are needed, says Citi. "Indeed, we expect an official request by Spain for an ECB bailout to trigger upward moves in gold in Q1."

ALUMINIUM: Smelter capacity is set to rise from 56,000 tonnes in 2012 to 72,500 tonnes by 2016, which would ensure prices remain flat, with downward pressure.

"Aluminum is expected to continue to trade in a volatile pattern within a $1,800-$2,400/t range going forward as 2012 trading patterns continue in next year," says Citibank analyst. "However, should any significant regulatory changes occur to, for example, LME warehousing regulations, then the balance of risk is on the downside to our 2013 price forecast of $2,100 per tonne."

STEEL: Steel production in the Middle East & Africa region is set to rise from 34 tonnes in 2011 to 57 tonnes by 2015, but will remain behind demand in the region.

However, overall demand for steel in key global regions is unlikely to materially improve in 2013, the bank says.

OIL: The Wall Street bank is quite bearish on Brent prices, suggesting average price of $99 per barrel /bbl in the New Year.

The big picture: the oil market is in the process of normalizing, that is, rebuilding a buffer of spare capacity. The way in which this happens would be for weaker markets to pressure Saudi Arabia (with some help from some other core OPEC members) to pull back on production. Citi has projected an 800,000 bpd cut in Saudi production in the first half of 2013."

However, subdued growth could be offset by regional conflict and supply issues from non-OPEC areas like the North Sea, keeping crude prices at historically high levels.

COPPER: Copper bulls are hoping that copper supply will fail to deliver in 2013, pointing to losses due to strike activity, ore depletion and project slippage as the reasons.

"Obviously these have been the reasons for poor performance in recent years. However, we believe that these factors will be less of an issue in 2013; leading to an expectation of total mine supply growth of 1.1 million tons, or 6.7%, for the year."

As such copper prices are set to remain depressed from USD7,970 per tonne in 2012, to USD7,300 per tonne by 2016.

WHEAT: Wheat is expected to perform strongly adding pressure on major importers such as Egypt and Saudi Arabia.

Total production is expected to drop 696 million tonnes in 2011-12 to 649.5 million tonnes in 2012-13.

"After rallying in sympathy with the row crops wheat has come out on its own, outperforming in 4Q (-3.75% versus -4.5% for corn and -8.5% for beans) and prices for the primary food grain are likely to remain strong through 2013; its historical premium to coarse grains of about USd100-125/bu likely intact after the longest period in history (during much of 11/12)," says the bank.

While Citibank remains bearish on commodities, it notes that there are still a host of opportunities available in the sector.

"Exceptional rewards from tail risk events should continue to make commodities an attractive investment vehicle for a wide array of portfolio managers, as no other asset class provides such an opportunity from wildcards," concluded Mr. Morse.

Analysts remain divided over the fate of the commodity supercycle, and whether it is truly over. Much of it is driven by global market uncertainty, and lack of growth in virtually all economies across the developed and developing world.

But it may not take much for commodities to rally once more: greater clarity on the U.S. economic outlook could spur growth in the New Year. With Chinese, Brazilian, Indian and Middle East growth stories remaining intact, it could well be that commodities are simply pausing to catch their breath.

© alifarabia.com 2012

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