cmdtyInsights Weekly Commodity Market Report

Commodity sector sees improved global demand but faces major potential risks from China

The commodity sector has performed poorly in the wake of the 2007/09 global financial crisis. The commodity sector continues to be undercut by (1) heavy supply in many commodity markets, (2) tepid global demand, and (3) the stronger dollar relative to 2006-07 pre-crisis levels.

The precious metal sector is the only commodity sector that is trading higher relative to pre-crisis levels. Precious metals have been supported by flight-to-quality demand sparked by the long slog towards normality in the wake of the global financial crisis. The markets remain nervous about the possibility that inflation could break out due to the massive balance sheet levels at the Fed, European Central Bank, Bank of England, and Bank of Japan. In addition, there continues to be concern about global financial risk in bubble markets and in global banking.

The agriculture sector is down -23% from Jan 1, 2007 mainly due to oversupply in many agricultural markets. This oversupply has been sparked mainly by the surge in South American production in most of the grain, livestock, and softs markets.

The industrial metals sector is the next-to-worst performer relative to 2007 at -38%, mainly due to supply-demand factors. The energy sector is by far the worst performing sector since 2007 at -83% due to heavy supply in the petroleum and natural gas markets.

While heavy supply will continue to hold down specific commodity markets, the overall macro picture for the commodity markets has improved this year. Commodity demand has improved due to the synchronized global economic expansion. The U.S. and Chinese economies have strengthened this year and Eurozone Q3 GDP growth reached a 6-1/2 year high of 2.5% y/y. Japan’s economy has perked up as well. Commodities have also seen support this year from continued easy ECB and BOJ monetary policies and from the sharp sell-off in the dollar seen earlier this year.

The main bearish factors for the commodity sector include (1) the possibility that further Fed rate hikes will lead to a sustained rally in the dollar, (2) tepid global inflation, which reduces demand for commodities as an inflation hedge, and (3) Chinese risks.

Chinese risks for the commodity sector will increase as Chinese GDP growth slows in coming years as the government puts more emphasis on the quality of growth rather than on quantity. In addition, the government’s deleveraging campaign to address the post-crisis debt explosion poses a big risk to the commodity markets. The Chinese 10-year government yield has already surged to a 3-year high of 4% and the government is cracking down on bad loans and the shadow banking system. In addition, many Chinese heavy industries as well as the real estate sector are suffering from overcapacity and need rationalization, which will hurt commodity demand.