By Natasa Stasinou
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Saxo Bank's head of commodity strategy told "N" this week that initial indications show that 2016's market rally, after a five-year slump, will continue into 2017.
Veteran trader and analyst Ole Hansen "hedges" his guarded forecast by pointing to the still unknown variable of a Trump presidency, the US dollar's course and even inflationary pressure building up in the Chinese economy. In general, he said the energy market is expected to stabilize, with the prospects of precious metals also appearing positive as the new year begins.
Asked about all-important growth in the Chinese economy, his prediction is that demand will continue to rise in the country, especially among the growing middle classes, although not at rates seen in previous years.
In 2016, commodities began the recovery from a five-year bear market. Do you expect the rally to be extended this year?
I think in short the answer is yes. I think the reasons why we returned to a profit last year if you look at something like the Bloomberg Commodity Index being up around 13% it was pretty broad based the rally we saw. I think if you look into 2017, one of the themes which is going to come back is inflation. We are seeing inflationary pressure starting to build in China and again if that is a theme that is going to get increased attention then commodities as an inflation hedge will attract some interest. Which sectors do we expect may do well? At this stage we are still trying to come to terms with Trump as President and also what that means. There’s a great deal of uncertainty that relates to the direction of key drivers such as the dollar, but in general we believe the energy sector slowly will make its way higher. It will be a bumpy road, it will be a rollercoaster ride, but the energy sector is bound to move higher. For precious metals we could see a revival there similar to what we saw last year, some of that depending on the dollar. The jury is still out on the dollar at the moment. There is still quite a big camp expecting the dollar to go higher for many obvious reasons. There also is some speculation that it actually could go weaker and Trump’s recent comments tend to support that view. A weaker dollar would be generally good for commodities. So we expect we are going to see a rise through the energy sector, through precious metals and potentially the agricultural sector where we have been under pressure for a good few years. To sum up in short, yes I do expect the rally to be extended this year.
Will China continue to support demand or could we see a sudden slowdown?
The sudden slowdown is probably not going to happen but the key question still is how much more additional stimulus the China government can provide without creating an even bigger debt bubble which is a concern. There are also some issues with regards to the currency. Their producer prices are going up and in response to that we have seen the currency come under some pressure in order for China to remain competitive on the international markets, but I think there will continue to be increased demand for energy because of the rising middle class, continued big demand for automobiles, automobile sales are still strong so that will continue. Some of the kind of questions more related to the heavy industrial commodities, steel, iron ore, where we did see a big rally during 2016, some of that speculative driven but also driven by initiatives taken by the government which may be faded out during 2017. Yes, China will continue to support demand but we should not expect the growth rate seen in the past, it will be a different kind of demand, it will be more towards the commodities required for consumer-based development. A sudden slowdown, I don’t see that happening. We have a general positive outlook for China but what’s key could be the relationship between the US and China and only the coming months will tell.
How could the Fed tightening and the strong dollar affect the commodities market?
That’s where we have the conundrum because Fed tightening is on paper dollar supportive because it raises the interest rate differentials between dollar and other currencies with the Fed almost being the only central bank at the moment in a tightening mode with most of the others are on either stand by or are still in easing mode. Based on the assumption that the Fed tightening will lead to a stronger dollar, then that could have a negative impact on commodities. The rising cost of funding at the same time as the dollar goes up is not what emerging economies need. A lot of the debit is in US dollars and rising debt burden would reduce the ability to service the economy in other areas. If it’s on the basis of the Fed tightening leading to a stronger dollar then it could have a negative impact on commodities demand.
Political risk was supposed to be a key factor for markets in 2016. However its impact was limited. Do you expect it to play a role this year? Could it drive investors to safe havens, like gold?
Political risks, there are going to be plenty. We have several unknowns, the biggest one being Trump. If his protectionist and isolationist policies, trade barriers and so on, then that could have a significant impact. But also in Europe later this year we have elections in the Netherlands, France and Germany and these are also important to follow because following Brexit last year there are clearly some concerns about the future of Europe and the Eurozone as we know it and that could also increase the political risk and also increase the demand for alternatives. I think we’ve seen some of that already since the middle of December where we have seen quite a decent recovery in precious metals, and the uncertainty related to Trump’s Presidency has been mentioned as one of the reasons behind the rally that we’ve seen during this time.
There is growing expectation of a further rise in oil prices, thanks to the deal between OPEC and non-OPEC producing countries to curtail their supply. Do you think the deal will work?
In short, the deal will work but it’s probably going to take longer than we currently expect. There is no doubt that we have seen quite significant steps taken by the major OPEC producers to signal that they have cut production, some by even more than what they initially stated that they would cut by. That is in order to send a clear signal to the market that they mean it seriously and that is also required because the ability to comply with stocks limits has been very poor in recent history and it’s also necessary to signal such a strong commitment in order to make sure that Russia gets on board. Russia with its 300,000 barrel a day is a key dimension to this process. The reason why I say it’s likely going to prolong is that we are seeing a pick-up now in production from what was formally known as high-cost producers, especially in the US shale industry. The high cost there is not so much high cost anymore. Most of these producers are now producing at a profit and that has triggered a revival in the number of rigs and is also triggering a recovery in the production. The unknowns and the speed at which we rebalance will clearly depend on production levels first of all in the US, but also and probably as important the two volatile countries of Libya and Nigeria. Both are producing well below their abilities and as long as they can see consistent improvement, such as we’ve seen in Libya in the past few months where security on the ground is starting to improve, then they will have the ability to increase production further. That will pose a major challenge to OPEC because each barrel that these countries increase production by someone else has to cut in order to maintain the trajectory of the timing of the market re-balancing.
In short, I think yes it is the right remedy, it sends a signal to the market and the market has bought into it very strongly. There is a record long position in the oil market held speculatively at the moment and that’s probably oil’s biggest challenge in the short term. But we have rallied 20% from the lows back in November and since then so far this month we are settling in to a relatively tight range. It does indicate that the buying interest has dried up and, at this stage, considering there is such a big position in the market, those holding on to those positions they need to be fed positive news in order to avoid the temptation of taking some profit. That in my view, raises the risk of profit-taking, at least in the short term.
Looking over the year, in the short term we see the risk of $50 before $60 as the greatest risk. When we move deeper into 2017, as long as global demand growth continues to be as strong as currently expected, which is in the region of 1.5 million barrels per day this year, then the market will continue its rebalancing process and that leaves it open for an end of year price close to $60.
How high could oil prices go and what will be the impact on importing economies in Europe?
As long as we stay within this relatively low range which we have at the moment where the upside potential above $60 remains reasonably limited then the implication for Europe is that it’s not going to have a significant impact. We are not seeing any spikes in the market, spikes will only be driven by geo-political events which we can obviously never estimate or foresee, but based on how the market is developing and the demand growth going forward, the current expectation now is that the oil price will generally rise by $5 a barrel over the coming couple of years so we are ending up towards the end of the decade probably closer to the $70 to $80 area. Having seen oil prices averaging $110 for three years from 2011 to 2014 that is something the market has seen in the past and it shouldn’t create much of a challenge.
While energy and metals are on the rise, the picture for agricultural commodities (grains and softs) is more mixed. Which are the factors that will define their course?
Weather, supply and demand and to a certain extent the dollar. The overhang of supply, especially if you look at the grains, has been built up following four good crop years and is clearly a challenge to the potential for grain prices to move higher. But having seen low prices most of last year there will be some speculation as we move into the Spring whether we are going to see some changes in the mix of what farmers are going to plant, especially in the US. That might add some support to some the likes of wheat potentially. Soy beans have picked up recently as there were some weather concerns in South America, especially Argentina, which has supported the market. That shows that any weather upset, whether shorter or longer term, has the potential of turning the market around and that’s really what grain markets from an upwards trajectory have to, well not hope for, because it’s not good news is grain prices go up too much, but it’s really the main driver for a potential recovery in grains.
If you look at soft commodities it seems like we have a fundamental bullish case for both coffee and sugar. We are seeing supply deficit again this year. Coffee production in Brazil is likely to be lower than we’ve seen over the past couple of years and that lends support to solid price there. On sugar and coffee there is a fundamental support; grains are still in the unknown and that depends on the weather.
