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Metals boom to survive bond spike Posted: Mon, 04 Jun 2007 [miningmx.com] -- DEMAND and supply fundamentals will continue to support commodity markets and are still strong enough to counteract any possible reduction in global liquidity conditions. That’s the view of Standard Bank, senior commodities analyst, Dr Walter de Wet. “Commodities differ from financial markets in that what matters most is the performance of the underlying economic fundamentals,” said De Wet. “Despite the recent US bond sell-off there is still enough physical demand for commodities from the world’s major commodity consumers to sustain the market while the supply of commodities is still under pressure.” De Wet’s comments come after a recent correction in the US bond market saw the yield on the benchmark 10 year US government note rise to a five year high of 5.327% on June 13, an ominous sign for global liquidity conditions. The bond yield spike sent jitters through commodity markets, and metals in particular, as investors withdrew money from riskier commodity-backed funds and resources stocks in favour of relatively safer US government debt. “What has changed is that some speculative demand has moved out of commodities and into US treasuries but the sustainability of this depends on the outlook for the US economy and the US dollar,” said De Wet. “The recent spike in the 10 year yield was not due to inflation but due to a realization that risk in the US was under-priced due to the question marks hanging over the US economy and the dollar.” Bloomberg News reported that the US consumer inflation measured just 1.9% in the year ending May, the first time during Fed Chairman Ben Bernanke’s 16 month tenure that US consumer inflation has fallen within the so-called comfort zone of 1% to 2%. Although the yield on the ten year US government bond recently fell below 5%, continuing uncertainty and volatility in financial markets as well as a cyclical upswing in global inflationary pressures prompted technical strategists at Citigroup Global Markets Inc. to say the yield on US ten-year treasuries could rise to a five-year high 5.33%. However, de Wet feels the risk of a US-led liquidity crunch is overstated. “Although there are a lot of mixed signals coming out of the US economy, we maintain our position that the probability of a rate cut this year is still greater than a rate hike,” he said. “Our general view is that the US economy won’t go into recession but will slow down as consumer spending slows, especially in the third and fourth quarters.” Even if a potential withdrawal of liquidity does occur en masse, Henk Viljoen, head of fixed interest at Stanlib Asset Management, said it would have only a limited impact on commodity prices. “The availability of cheap money, particularly through carry trades, does make for a certain degree of leverage in commodity positions by hedge funds in New York and London but in general commodity prices are more strongly linked to underlying economic fundamentals,” said Viljoen. “Speculators account for a swing-factor of around 25% either above or below the spot price of any commodity but overall commodity prices are still linked to broader economic cycles that are driving Chinese growth and infrastructure investment in emerging economies.” Nevertheless, Liston Meinjes, chief investment officer at Metropolitan Asset Management, said commodity markets were due for a correction. “The market may still be intact but it’s nowhere near as intact as some people like to think,” he said. “Commodity market jitters are not just a response to bonds but also supply. There’s quite a lot of copper coming on stream from the DRC province of Katanga, which suggests that the copper market might have turned. “Just because China is growing at 10% doesn’t mean the world is growing at 10%.” But according to De Wet global demand fundamentals outweigh any fears of a global supply catch up. Using an index based on the industrial production of the seven biggest oil-consuming countries weighted in terms of their demand for oil, De Wet found that commodities are still facing growing demand, particularly from China. According to Standard Bank Commodities Research the US is the biggest consumer of oil, accounting for around 25% of global demand. This is followed by China (8.5%), Japan (7%) and Germany (3.5%). De Wet’s index show that from 2002 to the current period, industrial production in the seven biggest oil consuming economies grew at an average rate of 6.6% y/y when weighted according to their oil consumption. This was more than double the growth rate between 1996 and 2001 when De Wet’s index showed industrial production in the seven biggest oil consuming countries grew just 3.2%. “If you take China out of the equation then industrial production between 2002 and now is just 3,7%,” he said. “That shows how significant China is, so even if money does flow out of other emerging markets I can’t see it affecting China to the extent that its demand for commodities will collapse. Click Here to subscribe to our daily newsletter
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