A remarkable rebound after an early summer lull

The commodity market has witnessed a remarkable rebound since June. The Handelsbanken commodity index, including futures from all sectors, gained 10 %, which is due to a combination of various risk premiums, a lower USD and further cutbacks in Chinese supply reform. All told, there is a fragile trend of rising prices.

Oil stuck in loop

The price of crude oil has not been this uneventful in a long time. Over the past 12 months, the oil price has traded within a tight range, spanning just USD 13/bbl. However, in terms of short-term swings, the summer recovery has been relatively strong, up 15% since the low point in June.

The summer driving season in the US has been surprisingly strong given weaker consumption data during the spring. Consumables used to be a good leading indicator for fuel demand during summer. Yet, this year’s driving season has drawn on stocks, which are now lower than in 2016. However, that does not lead us to change our view of the oil price (USD 40/bbl at the end of 2017), as US oil production continues to increase and driving season demand is of course seasonal.

Venezuela has been the most relevant risk premium for commodity markets during summer. None of the remaining OPEC members are able to compensate for a full-scale breakdown of the Venezuelan oil tap.

The heavy crude nature of Venezuela’s oil presents a suitable weak point for the Trump administration to exploit. Venezuela needs to import light crude oil to blend with its domestic production to create a saleable product. Hence, there are two main risks for oil prices in Venezuela, with the first being full-scale export sanctions from the US (in our view, imports elsewhere will come at a higher cost, but this problem could be solved). There is plenty of available light crude oil in Western Africa after the US lowered imports in the wake of the shale revolution. The second risk is a default in Venezuela. In such a scenario, we struggle to see oil workers continuing to work if salaries are frozen.

On the other hand, OPEC faces new challenges. Ecuador was the first member to leave the production accord officially and start to increase production and exports to meet its fiscal needs. Iraq followed shortly after, but now regrets this decision after an OPEC summit focusing on fading compliance within the group.

North Korea boosts bullion demand

The escalating conflict around the Korean Peninsula affects commodities due to the lower USD and investors shunning risks. However, we believe this is a short-term story. Nevertheless, risk-averse strategies benefit gold. Prices approached USD 1,300 per ounce for the third time this year, fuelled by tougher rhetoric from Trump and North Korea’s improved ability to manufacture nuclear weapons.

China forces cutbacks

Beijing has escalated the cutback campaign of unprofitable commodity production. Coal mining is now halfway to the 2020 target. Other bulk commodities are affected as well, particularly iron ore, which had the greatest price gain of all commodities during the summer, up 40% since June compared to coal’s 20%.

A cutback in domestic iron ore production spills over to freight rates. Capesize ships more than doubled during the past month. Buyers in China are looking to stockpile steelmaking raw materials before a crackdown on production creates a higher need for imports amid seasonally-slower domestic production during the winter months. Freight rates used to be volatile, but sometimes they offer clues about spot demand. They add a piece to our model-based calculation, showing Chinese steel mills have not been better off in terms of profits during the past five years.

Base metals on solid ground

Of the summer gains, we believe base metals stand on the safest ground. However, aluminium has gained from announced cutbacks in China. Yet, in our view, that trend is vaguer than those for steel, iron ore and coal.

Others are trading high for good reasons, with zinc and copper at an impressive USD 2,900/t and USD 6,400/t respectively. However, this mirrors the current market balance, with mining in a sweet spot among the commodity producers. Nickel is still the laggard among base metals after the Philippines removed the mining closure campaign and miners triumphed against President Duarte’s environmental minister, Lopez. We believe this market will be flooded for a long time.

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