COMBI Series6 Unlocking the potential of the world’s commodity market

At Liontamer we see several fundamental drivers of commodity prices – some are already present while others will come into effect over the next few years:

• The global recession has deflated prices which has in turn led to production cuts and a reduction in supply
• The industrialisation of developing economies, especially China and India, continues more or less unabated
• There is a wall of infrastructure and energy spending as economic stimulus packages start to take effect and global demand rebuilds
• Growing wealth in the emerging markets means there are an increasing number of middle class consumers eating meat, grains and dairy products
• The bio-fuel industry and extreme weather events are adding pressure to key agricultural commodity prices
• There is a long-term trend of relentless population growth.

Oil demand forecast to rise
There seem to be two leading actors in every commodity story and it's clear the key players here are China and India.  These two emerging super-economies remain on track to grow by more than 8.5% and 7.5% per annum respectively over the next ten years.  In particular, all eyes seem to be on the Chinese economy, whose continued growth seems critical to this nascent global recovery.  And if growth is fuelled by oil, then China's production engine must be revving.  Chinese crude oil imports for July were over 42% higher than for the same month last year and have surpassed the last peak in demand back in March 2008, when China was stockpiling oil in preparation for the Olympic Games.  Barclays are picking that oil demand in general will skyrocket.  Barclays Capital recently announced that they are "forecasting an upswing in global oil demand from Q2 into Q4 that is seven times larger than the forecast of the International Energy Agency, and we still see upside risk in our forecast."  This is a significantly bullish view from Barclays and, if correct, further strengthens a view that NZ investors should have an exposure to a range of commodities, not just oil, as China ramps up production again.

China: restocking not stockpiling
It appears that China is not just buying petroleum products; demand from China (and India) has been instrumental in driving a variety of commodity prices up. China, as the world's fastest-growing major economy, consumes more than a third of the world's aluminium output, a quarter of its copper production, almost a tenth of its oil and accounts for more than half of trading in iron ore.  The price of copper, traditionally a barometer for economic activity because of its use in housing and construction, has doubled this year.  Aluminium, used in cars, planes and construction, is at nine-month highs while nickel, a key ingredient in stainless steel, is at one-year highs. Clearly a bounce has already occurred, albeit from low bases, but is it a blip in a prolonged bear market or the start of a longer-term recovery in commodity prices?

At Liontamer, we subscribe to the view put forward by Barclays Capital that surging Chinese demand for commodities is not a case of stockpiling but instead reflects a major move to restock following declining inventories in 2007 and 2008.  We believe both China and India will continue to be major commodity importers as their respective economic stimulus packages, announced in late 2008, start to take effect throughout the second half of 2009 and beyond, and deliver large infrastructure and public works programmes.  

In addition, as more developed nations come out of recession and confidence grows that the Asia-led recovery has some momentum, increased production combined with low inventories, especially in the US, should start to have a flow-on effect on demand for commodities.  Global production already appears to be starting to return to growth.  The US has reported a lift in industrial production of 0.5%, the first rise in nine months and even Japan's economy is showing signs of improvement, recording GDP growth of 0.9% in Q2 this year.