Commodity markets outlook

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With the weakness in the dollar encouraging speculative flows into commodity markets and the gold price trading close to its highest levels since 1980, James Steel, HSBC’s chief commodities analyst, will answer FT.com readers’ questions on commodity markets in a live debate on Monday October 1 from 2-3pm BST.

Mr Steel, a frequent speaker at commodities related conferences, is well positioned to answer questions on the long term prospects for precious and base metals, price forecasts and the outlook for global commodity markets.


Do you think that the present price level for commodities is a short term phenomenon given that economic growth is due for a slow down? The present price of oil and the level of debt of American consumers must surely cut back the demand for Chinese exports. Maybe gold is an exception due to its value as a hedge on inflation.
John Contogeorge

James Steel: Firstly we should start from the point that commodity prices are certainly high, especially when compared to the 1990’s or even a few years ago. Some commodities such as gold however are not at all-time highs in real inflation adjusted terms. Commodity demand is largely a function of economic growth and any real slowdown would impact commodity demand.

However much would depend on where the slowdown were to occur. Should emerging markets slow dramatically, the knock-on impact on commodities would be palpable in my view. A slowdown in the US, although it is a large commodity consumer may not be as devastating for commodity demand one might initially think. Certainly the demand for US imports from China and elsewhere would be reduced by a slowdown but economies such as China are engaged in long term infrastructure programs that assure some degree of commodity demand even in spite of a US slowdown.

Savings levels are also high in these nations which could be diverted to commodity consumption if necessary. The price of oil is high but gasoline demand in the US is also a function of employment as well as income and while the unemployment level may or may not increase, much driving in the US is nondiscretionary in nature. Also as far as emerging nations are concerned although oil and other commodity prices are high, most emerging nations have vastly greater levels of foreign exchange and dollar reserves to pay for higher commodity prices.

Current prices will also have to accommodate increased commodity supply in future as producers react to high levels of price and demand. Gold as you point out is an excellent hedge against inflation and is often employed as a safe haven.


When will the excellent performance seen by the gold and natural resource equity funds stop? And will there be a hard or soft landing?
Steven, UK

James Steel: Unfortunately as I am not an equity analyst I cannot answer a question on equity funds, even as they relate to natural resources. However in more general terms I would repeat an answer made to an earlier question that global demand for commodities will likely remain strong base on global growth. If a slowdown in the US, be it hard or soft, is contained mostly to the US, overall commodity demand is likely to be relatively unphased. However it is important to note that producers are gearing up output where possible and are likely to continue to do so.


To what extent is the current price of copper driven by speculative flows? Is there widespread use of program trading? Given an investment horizon of, say, five years, would you invest in copper mining stocks?
Rolando S. Villacorta, Jr, US

James Steel: It is difficult if not impossible to delineate between what could be termed as ”speculative” versus other forms of investment. It has long been my belief that speculative investors receive undue criticism for price fluctuations, that may be otherwise hard to explain.

Trading programs are used by some investors in all commodity markets as well as other markets and I am not aware of them being more or less influential in any particular market. I am not sure if the term speculative investor is really helpful when seeking to understand the commodity markets, as it draws differences between investors, which I am not sure are valid. Unfortunately as I am not the equity analyst I do not have a view on copper mining stocks.


How does the current commodities rally especially crude oil and gold support the global growth in the face of US economic slowdown. Can global growth be supported by commodities demands without a recourse to other markets?
Mohammed Isah

James Steel: The high price of both oil and gold lend credence to the idea that world economic demand is vigorous and that global growth will remain strong. The recent IMF outlook confirms a positive global not to say robust economic outlook, particularly in countries where commodity demand is increasing most rapidly.

Global growth, at least as far as commodities are concerned can remain strong even if the US slows. Although undoubtedly an important economy, commodity demand in the US is largely stable. Demand is increasing most rapidly in emerging nations. It is this marginal increase in demand that is largely determining prices.


What will be the future effect of the current credit crisis on commodities prices, if any? Some experts say that we are in a bullish cycle for commodities which could last for seven more years. Do you agree?
Laurent Lyon, Senior Relationship Manager, Trade Finance, BCV Switzerland

James Steel: The fallout from the credit crisis may work through the commodity markets in different ways over varying time horizons. If the credit crisis pushes the US into recession there will naturally be a negative impact on most commodities. However the crisis has occurred at a time of unprecedented demand for commodities and if the US is the only major economy to slow as a consequence of the credit problems, then the impact on commodity demand will be limited.

It is possible some ramifications of the credit crisis are potentially supportive of commodities. If credit problems in the US weigh on the US dollar, as the Fed and other central banks increase liquidity in response to credit market woes, the increase in liquidity may put an extra bid into commodities, including gold, particularly if lax monetary policies are seen as inflationary. Demand for commodities is likely to be firm for at least the next several years.


Although a lot of new mines are starting production or will so in the mid term, a new supply side bottleneck might show up in form of limited capacity by smelting and refining operations. Could you give us your view on how much progress has been done on this front, especially regarding the Platinum Metals Group.
Michail Paraskevopoulos, Amsterdam

James Steel: This question raises the point that once ore has been successfully mined it must then be processed. The constraints in the mining sector, such as the lack of availability of new projects, manpower and skills shortages, etc, also apply to the processing of metals as well as the production. This is an important issue to consider.

The availability of power, transportation problems, skills shortages and available sites are also impacting smelting and refining operations, as they are in mining. We see similar constraints in the global petroleum industry where the problem is as much one of refining the oil into gasoline or other products as it is in drilling for oil. Bottlenecks in metals smelting and refining will remain on balance a bullish factor for the foreseeable future.

It is important to remember that it is the refined product that is most actively sought by the market. In periods of tight supply the price premium will go the refined versus the semi-refined product. The metals industry has dome a superb job at increasing refined product output but bottlenecks remain. The platinum group metals are subject to similar conditions, but is important to note the metals industry has always been a reliable supplier to the market.


Do you think that the demand for commodities from the Bric economies would be sufficient to offset impact of a potential slowdown in the US economy?
Ahmed Sule, London

James Steel: Simply put, yes I do. The world commodity markets are no longer dependent on the US as the engine for demand. The US and other mature economies have stable commodity demand which usually rises by less than the percentage increase in GDP. This is in part due to greater efficiencies in OECD economies and the shift to services which are less commodity-dependent.

The Bric and other emerging nations are in a period of commodity-intensive growth. This includes petroleum, grain and metals. There are also largely on a self-sustaining course of economic development and do not need the US as an export market to the degree that they did just a few years ago to ensure economic development. I suspect global commodity demand will remain high for several years to come.


Do the current values of gold, palladium and platinum reflect the real market valuations of precious metals, or they are the products of speculative interest created in conditions of volatility on credit markets? What are the differences between the listed metals valuation trends?
Anon

James Steel: ”Speculative interest” is often blamed for high commodity prices, especially in the precious metals. Short term speculative activity I believe will not impact the price of any commodity in the long term. Short term investors, if they do not read the underlying fundamentals correctly are usually punished by the market. In the case of platinum and palladium, there are sound underlying arguments for high prices. Demand for auto catalysts in particular and the difficulties in raising mine output support platinum in particular.

As far as gold is concerned, dollar levels and constrained mine output are also positive supporting fundamentals. It is important to remember that gold is a safe haven instrument and as such is behaving properly when it reacts to sources of financial or economic stress such as the credit crisis or volatility.


In light of structural dollar weakness, do you see significant demand for gold emerging from the central banks of Asia and elsewhere?
Paul Bayliss, New York

James Steel: There is a very powerful argument that long term structural weakness in the US dollar presents central banks, particularly those in the emerging world, with a reason to increase gold holdings as part of their foreign exchange reserves. Gold holdings among central banks are unevenly distributed however.

Many European central banks for example hold gold deposits in excess of 50 per cent of their foreign exchange reserves, and these banks have been sellers of gold. Conversely many Asian central banks have gold holdings that barely amount to a few percentage points of foreign exchange reserves or less; these same banks are heavily ”overweight” US dollars.

In order to safeguard against the adverse impact of further dollar deprecation there is a sound logic that some central banks should increase gold holdings. If official sector banks do diversify even modestly out of the US dollar, it is possible gold would be a beneficiary. This is a much talked about subject in the gold market. To date however, it is fair to say that with a few exceptions, central banks have not dramatically increase their gold holdings, at least not yet.


In the short term we can observe a correlation between the strength and weakness of the dollar and commodity markets? How far does the dollar matter for commodity markets (especially metals) in the long term?
Nadja Bickelhaupt, Moscow

James Steel: The value of the US dollar is perhaps the most reliable and consistent long term influence on the precious metals, especially gold. This is perhaps understandable as gold may be viewed as the world’s supreme hard asset and the dollar the world’s supreme paper asset. It is logical therefore the two would exhibit an inverse relationship.

As gold and other commodities, are traded in US dollars, the value of the dollar has enormous impact on mining costs and mining economics in local currency terms for producers outside of the United States. The value of the US dollar can therefore influence long term mining decisions. Additionally the price of gold in local currency terms fluctuates for consumers outside of the US dollar bloc with changes in the exchange rate.

For countries where we see a high degree of price elasticity, such as India for example, this can be an important factor in determining gold demand. A high dollar over many years can reduce the physical demand for gold as well as for other dollar denominated commodities. A weak dollar can likewise stimulate demand, with a consequent price impact. Current dollar weakness is accelerating already strong global commodity demand, in my view. Note this inverse relationship can breakdown sometimes for a few months but has always been re-established and is consistent over time.

From an investment perspective, the value of the dollar is a reflection of US monetary policy, relative growth rates, inflation rates, interest differentials and other factors. which directly impact the demand for gold. A long run depreciation in the US dollar makes hard assets such as gold more attractive, particularly if conditions are also seen as inflationary or potentially inflationary. Periods of dollar strength tend to depress the price of gold, sometimes for many years. Note the price of gold was consistently weak for most of the 1990’s, a period of relative dollar strength. In the late 1970s gold strengthened in line with a long period of dollar depreciation.

In the last few years, gold has appreciated largely in league with US dollar weakness. A number of academic studies have been done on this issue which have consistently reaffirmed the relationship. Some of these studies are available for the World Gold Council.


I would like to know your gold price forecast for gold for the next 12 months.
Juan Carlos Romanelli, Argentina

James Steel: Our current price forecast for 2007 is for an average gold price of USD680/oz and average of USD660/oz for 2008. Bear in mind the price of gold was near USD600 at the beginning of 2007 and for the year so far has averaged about USD666/oz.

We expect gold to remain strong for the rest of the year. Also the market is likely to have a wide trading range, giving investors plenty of room to actively trade the market.


About the expert

Mr Steel’s primary duties at HSBC include the production of daily market reports. He joined HSBC in May 2006. Previously Mr Steel ran the New York research department for Refco, a large US commodities brokerage house. He has also worked for The Economist in the Intelligence Unit covering commodity producing nations.

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