Forecasters see most commodities rebounding in 2010

One of the most anticipated, and well-attended, sessions in this year’s PDAC convention in Toronto was headlined Commodities and Market Outlook. The intense interest is understandable. After brutal price declines in many commodities, delegates were anxious to know what’s in store, and in particular whether there was any prospect for a recovery.

While the market for each commodity is different, observers see markets remaining weak for most of the year, only starting to exit the doldrums next year.

Alan Williamson of Galena Asset Management in London set the tone with a market overview, saying that developed countries are in a period of weaker growth, so emerging economies will need to lead the recovery. On the positive side, global industrial output is close to bottoming, although Williamson only expects a tepid recovery.

And because inventories are building, prices have been pushed down near production costs. Williamson expects prices to remain weak in 2009-10 as governments reflate the financial system through 2011. Although downside is limited from these price levels, prices are also unlikely to rise while oversupply persists.

Underlying the severity of the recession, Williamson says that this year will be the first since World War II in which the global economy contracts. The downturn is most pronounced in developed countries, which are pulling down emerging economies too.

Paradoxically, the weak state of credit markets sets the stage for a future recovery in commodity prices, since the “lack of project financing is impacting future commodities supply,” according to Williamson. The delays and cancellations in multiple projects should ensure a long-term recovery.

As so vividly demonstrated by the crash in auto sales, U.S. consumers are cutting back on spending, likely ushering in a protracted period of sub-trend growth, Williamson forecasts. The credit crisis has strengthened the greenback, historically a negative for commodities, but this relationship explains commodity price movements only partially, and it does not affect all commodities equally, with the strongest influence felt on the gold price.

The slowdown in China was made worse by government tightening in early 2008, and the government is now reversing this policy. Williamson sees recovery in Chinese construction as key to commodity markets.

Global industrial production is down, showing a 7% decline year-on-year in December. The slowdown has triggered a collapse in metal demand, further amplified by destocking.

Industrial downturns are nothing new, Williamson says, and growth always returns eventually. But this downturn is unusually harsh, with developed economies declining by 10% from the peak in January 2008. The best-case scenario would be for the economy to hit a trough in April-May, and start recovering thereafter. This would see global industrial production shrinking by 7.5% year-on-year in 2009, followed by a 10.6 % growth in 2010.

But a more likely scenario would see a lukewarm recovery followed by another dip in industrial production. Under this slower recovery scenario, global industrial production would shrink by 7.6% year-on-year in 2009, followed by a muted 4.8% growth in 2010.

The recession has shifted base metal markets into surplus which will persist in the short term despite cutbacks to production on many mines. Williamson sees the aluminum market moving into balance only in 2012. The copper and zinc markets look firmer, and are anticipated to move into deficit that year. Williamson’s most surprising forecast sees the lead market moving into deficit as early as next year.

He summarizes by saying that the trough of the recession is probably close, anticipated to arrive in the second quarter. Commodity prices should bounce as extreme pessimism passes, but the recovery will probably disappoint. Recovery in China will be key to commodity demand.

Fundamental improvement is still some way off: Williamson expects that it will arrive only in 2011. Commodity inventories would continue to rise as markets remain in surplus. Excess capacity would overhang the market for some time, forcing producers to maintain production cuts.

Andrew Keen, senior analyst at Sanford Bernstein, who spoke about copper, said that copper prices show an inverse relationship to inventory levels. The lower inventories go, the higher prices tend to be pushed. But as inventories rise, they tend to push copper prices down to the marginal cost of production.

Keen says that this decade has seen poor copper supply growth. One of the reasons is a decline in head grades. Keen estimates that between 1996 and 2008, average copper head grades declined from 1.37% to 1.01%. Another factor weighing on copper supply is earthquake activity in Chile.

Turning to the demand side, Keen estimates that 2008 copper demand from developed economies was 7.1 million tonnes, and from developing economies 11.4 million tonnes, for a total of 18.5 million tonnes. For 2009, he sees a 3.7% decline from that level. But he also forecasts that demand will snap back in 2010, recouping this year’s declines, and bringing 2010 demand back near 2008 levels.

Copper demand has not been destroyed as badly as expected. Coupled with constrained supply, this should limit surpluses. Keen predicts copper prices to average US$1.65-1.67 per lb. this year.

Keen seems none too impressed with the production potential from projects slated to come on line by 2017. Every proposed project has problems, such as political risks, large capital costs etc. Potential projects look high risk and low quality.

However in the short term the market remains in surplus, and Keen forecasts that it will likely get worse before it gets better. He sees a 500,000 tonnes surplus this year, falling to 150,000 tonnes next year.

As positives for the copper market Keen counts modest hikes in inventory, a poor project pipeline, and project deferrals and delays.

Keen expects copper to be one of the strongest commodity performers once the current down-phase passes. “We believe that copper will be relatively well positioned amongst metals for the recovery phase of the current cycle,” he says.

The zinc market was reviewed by Mark Patell of Xstrata Zinc. With zinc being used mostly in the automotive and construction sectors, demand is closely tied to the state of the global economy.

Patell sees a strong supply-side response to the recession. He estimates that zinc supply will be cut by 9% this year, exacerbating future supply deficits when demand growth returns.

But the most important underlying trend remains the population growth and urbanization in the developing economies. Increasing GDP growth per capita implies increasing metal consumption. Patell concludes that the long-term positive demand trend for commodities remains intact.

Patell’s talk did not include projections, so it is interesting to look at forecasts from a third party such as metal consultants GFMS. The London-based company sees a surplus of 210,000 tonnes zinc this year, but this will occur in the first two quarters, with the market moving to a small deficit in the second half of the year.

Zinc prices are seen retreating from US$1,250 per tonne, but the downside is anticipated to be limited to around US$1,100 per tonne. Prices are projected at US$1,200 per tonne in the third quarter, rising to US$1,300 per tonne in the fourth quarter. Prices next year are seen in a range of US$1,100-1,800 per tonne, with an average of US$1,550 for the year.

Turning to iron and steel, Phil Newman of CRU Strategies does not paint a rosy picture for the steel industry in 2009, projecting an 8% decline in hot metal production, or 65 million tonnes down. The impact on iron ore demand is profound, with demand falling 20 million tonnes in 2008, and a projected 100 million tonnes in 2009.

Newman expects this to weigh on prices, with prices of iron ore fines in Hamersley, Australia, anticipated to fall 25% year-on-year in 2009, to about US$109 per dry metric tonne unit (DMTU) from about US$145 last year. (Dry metric tonne unit is one tonne of contained iron.)

But Newman sees the market approaching an inflection point: a decline in domestic iron ore production in China owing to declining grades, rising costs and falling prices, which together are making some mines uneconomic.

Looking to 2010 and beyond, Newman sees a strong rebound in steel production. For example, in 2010 he anticipates production to rebound by roughly 7%, to about 1.3 billion tonnes, almost back to 2008 levels. And once the rebound train starts moving, there is no stopping it, with steel production growing about 6.5% in 2011, 5% in 2012 and 4% in 2013. Newman forecasts that, in 2013, steel production will exceed 1.5 billion tonnes.

This translates to higher iron ore demand, forecast to increase by about 100 million tonnes in 2010 and 110 million tonnes in 2011. Demand would continue to increase, albeit at a more moderate pace, rising by about 80 million tonnes in 2012, and by roughly 65 million tonnes in 2013.

The trend would be replicated in seaborne iron ore. After a projected 5% decline in 2009, it is anticipated to rebound by 10% next year. Again, the trend is forecast to continue, with 2013 seaborne iron ore projected to be 330 million tonnes higher than 2007 levels.

Meanwhile, iron ore exports from India are forecast to collapse to 40 million tonnes this year from 100 million tonnes in 2008. Tonnages would start recovering slowly in 2010, but are projected to reach about 70 million tonnes in 2013, well below 2008 levels. As a result, Australia and Brazil will step in, increasing their market share at India’s expense.

Newman concludes that “the party will continue, although the music has been turned down.”

In his talk about the uranium market, Greg Barnes of TD Newcrest pointed to a number of factors acting in the market. The credit crunch has caused forced selling by investors. Meanwhile, requirements from utilities are well-covered through 2010. Lacking an incentive to buy, utilities have been sitting on the sidelines. Although mine supply continues to miss targets, there are no supply shocks. India is re-entering the market as a buyer, increasing demand.

With a benign supply-demand picture, the U.S. Department of Energy has announced plans to sell surplus uranium. Barnes concludes that the short term will see a balanced market or a surplus.

Meanwhile, long-term supply is still a concern, with start-up dates of major projects (Cameco‘s (CCO-T, CCJ-N) Cigar Lake project in Saskatchewan, and BHP Billiton’s (BHP-N, BLT-L) Olympic Dam mine expansion in Australia) still unclear. But Kazakhstan has been increasing production.

Barnes projects prices rising to US$60 per lb. uranium oxide in 2009 from US$42.50 at presstime. Prices are projected to rise further to US$70 in 2010, declining to US$60 in 2013, and US$50 in 2014 and 2015.

Jim Steel, an analyst with HSBC securities, covered the gold and silver markets. Steel points out that, with the exception of rice and cocoa, gold was the best performing commodity in 2008. And this performance was against a backdrop of declines in most other asset classes.

Steel concludes that gold is an excellent safe haven and portfolio diversifier, having proven itself as a hard asset during the credit crisis. As demand for other commodities declined, demand for gold increased, seen as a safe haven. And holdings of gold ETF’s (exchange-traded funds) have proved stable.

Steel says that if the U.S. Federal Reserve embarks on a policy of quantitative easing, money supply could grow, weakening the U.S. dollar and providing support for the gold price. This could happen despite lower inflationary expectations, with HSBC expecting global consumer prices to rise only 0.7% this year.

Meanwhile, the supply side is challenged. Mine supply stood at almost 2,450 tonnes gold in 2007, declining to about 2,430 tonnes in 2008, and to an estimated 2,400 tonnes in 2009. Jewellery demand is estimated to absorb 2,250 tonnes this year.

Shifting to the silver market, Steel says that with growing silver holdings in ETF’s, demand from ETF’s has become an important factor in the market.

The silver price does not affect mine production strongly, since most silver is a by-product of copper, zinc and gold mines. Steel projects an increase of 15 million oz. in silver production in 2009, to 695 million oz.

Most of the industrial consumption of silver goes to electrical and electronics applications. The slump in semiconductor sales implies lower industrial demand for the metal.

Steel estimates that mine supply will exceed industrial demand for silver by about 90 million oz. in 2009, with the difference taken up by investment demand, leaving silver vulnerable to changes in investor sentiment.

Moving to the platinum market, Tom Kendall of Mitsubishi points to the collapse in auto sales, where platinum is used as a catalyst, as the main factor behind the decline in demand. However, jewellery demand, which is price-sensitive, has picked up some of the slack. Investment demand is increasing, with rising platinum holdings in ETF’s.

Mine supply is highly concentrated, with about 75% coming from South Africa. Supply has responded to the crash in prices. Kendall estimates supply at 6.2 million oz. in 2009, 1 million oz. less than the number projected a year ago.

Kendall sees a number of challenges on the supply side, including falling grades, infrastructure problems and higher royalties. He says that the supply of scrap is correlated to prices.

Kendall sees a slow recovery in the auto sector, implying a slow recovery in platinum demand. But he also sees a number of positives for the market, including a slow supply response from mines, the possibility of a rebound in demand from China, stricter vehicle emissions standards, and low inventories.

Kendall forecasts an average platinum price of US$1,080 per oz. this year, with a possibility of a strong rally in the fourth quarter. He believes that the platinum price is unlikely to remain below US$1,200 per oz. for an extended period.

Dudley Kingsnorth of Industrial Minerals Company of Australia threw some light on an obscure group of commodities known as rare earth metals. He estimates 2008 demand at 124,000 tonnes valued at US$1.25 billion, and projects demand increasing to 200,000 tonnes in 2015, valued at US$2-3 billion. Depending on the metal, prices average US$9-11 per kg.

China is the main supplier, and government-imposed constraints on exports are causing companies to evaluate projects outside China.

Kingsnorth forecasts that by 2015, demand for dysprosium, terbium and yttrium will be higher, with prices for the three metals anticipated to be firm. Demand for neodymium and lanthanum, currently in balance, may also increase. But the market for cerium is showing a surplus, and is anticipated to remain over-supplied.