Commodities: Has the tide turned?

Commodity prices are gradually recovering, which is good news for the commodity based South African economy, and the outlook for commodities during the second half of 2009 may be even brighter.

Recoveries in commodity prices follow the massive commodity fund liquidations and inventory reductions at mine, refinery and final consumption levels in December which, in some instances, gave rise to record stock levels of industrial metals on the London Metals Exchange, says Dr Prieur du Plessis, Plexus group chairman.

According to Du Plessis, the recovery in metal and oil prices should be seen in context. “The sharp price declines rendered a significant quantity of global production uneconomical, resulting in substantial cutbacks in production already seen and planned for the next two to three months,” says Du Plessis.

Du Plessis contends that China continues to be the main driver in the metals market. The Chinese purchasing managers index (PMI) rebounded to 52.4% in March 2009, up from 49% in the previous month.

“The index was back to the expansionary zone of higher than 50% for the first time since October last year,” says Du Plessis. “China’s improving PMI seems to indicate that the country might have seen the worst of the GDP growth statistics. The first quarter’s growth rate may surprise on the upside and could come in at higher than 8% year on year.”

According to recent data, the Chinese PMI New Orders and New Export Orders lead metal prices by approximately one month, providing upward momentum to the rally in metal prices.

With a large part of China’s own mines uneconomical, that government is buying its own domestically produced metals at set prices to keep its mines afloat. China has also accumulated significant amounts of metals at the bargain prices to bolster its strategic reserves.

China’s aggression in the commodity markets, especially copper, is also evident as some major copper smelters in Japan have sold out their total production to China two to three months hence.

Du Plessis believes the uptrend in commodity prices since the extreme lows in December should be considered as a return to equilibrium due to cutbacks in production and China’s activity in the commodity markets rather than the start of a strong bull market.

“The expected rise in manufacturing PMIs in coming months to neutral levels is likely to underpin metal and oil prices. Significant volatility can be expected, as positive news is likely to be counterbalanced by high inventory-to-sales ratios in mature economies,” says Du Plessis. “These are likely to continue to depress demand and limit rises in commodity prices.”

According to Du Plessis, the outlook for commodity prices in the second half of this year is encouraging. “The closure of mines and mothballing of smelters in the mining industry are leaving the industry lean. Any significant improvement in the global economy’s fundamentals is bound to be reflected in higher commodity prices. Furthermore, a weaker US dollar will be supportive of commodity prices expressed in US dollars.”

“Investors should ensure their equity portfolios are not too underweight in mining and resources shares,” says Du Plessis. “However, be sure that you have a long-term investment horizon and can stomach the volatility.”