© Eugen Weinberg
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Commodities sank to their lowest level since 1999 last Wednesday amid concerns that a glut in commodities will worsen as the economy of China grows at the slowest pace in more than two decades. While the oversupply remains, central bank's attempts to calm markets roiled by the unexpected devaluation of the Yuan earlier this month are giving commodity bulls some relief. Based on that, what is your current outlook on the commodity market?
The current price weakness of commodities is due to a combination of factors. First of all, there is the significant appreciation of the US Dollar. For years there has been a fairly stable negative correlation between the US Dollar and commodity prices. However, the weakness of commodity prices cannot be explained only by the strong Greenback. In addition, expressed in Euros, commodity indices are now trading below the level they stood at the start of the year.
Another negative factor was the stock market turmoil in China. A close correlation has been observed recently between movements on the Chinese stock market and prices of copper and crude oil. We think the concerns over demand prompted by the recent equity market crash are exaggerated, though. In fact, there is a very low correlation between equity market performance and economic trends in China. Note that equity prices more than doubled in the preceding 12 months despite a steady slowdown of economic growth. There was also no obvious asset-price effect during this period, which could have offered a stimulus to private consumer spending. Demand for gold actually declined, because people invested in shares instead.
A more serious worry is the recent economic data from China, which have been far from impressive. However, growth should stabilize in the second half of the year due to support measures by the government and central bank. Further stimulus measures are likely to be adopted and implemented by the government, if needed to support the economy.
A hard landing for the Chinese economy would deal a severe blow to commodity demand, since China is by far the largest purchaser of many industrial commodities. The price fall in recent weeks was therefore owed mainly to concerns about a collapse of Chinese demand, and moreover, it was to a large extent speculatively driven.
While the price decline of the past years was in line with the weaker demand growth and the strong expansion of supply, we regard the recent negative price dynamics as exaggerated. Many commodity prices have fallen to such low levels that a significant portion of production is already unprofitable. In the long term, prices should actually be higher than the so-called marginal costs of production, i.e. the costs of additional production. This is because demand for commodities rises every year almost without exception.
Since exaggerated concerns about Chinese demand are ebbing and speculative short positions can be expected to be covered, we forecast rising commodities prices on a medium-term perspective. The looming reduction of supply should also support the price rise. At the end of the year, most commodities should therefore trade at higher price levels than at present. In the near term we believe commodities prices could remain under pressure.
The fears over China's economy have gradually faded away in the US, where the economic data showed that the country's GDP rose 3.7% in Q2, dragging gold prices down more than 2% over the course of the previous week. What other factors could determine gold performance in short-term and in long-term run?
Until recently, events in Greece and China affected the gold price far less than the market's wait-and-see attitude regarding the timing of the first rate hike by the US Federal Reserve. As long as uncertainty persists in this regard, the gold price is unlikely to recover significantly. We remain convinced that gold will regain strength once uncertainty over the start of the tightening cycle has dissipated with the first rate hike.
Another factor is a physical demand for gold in the important Asian countries, which is likely to rise considerably in the second half of the year, boosted by lower prices. Recent negative experience of China's shares may well rekindle interest in gold among Chinese households. In India gold demand is also likely to be higher during the autumn holiday and wedding season.
A risk factor remains the weaker monsoon season caused by the El Niño weather phenomenon so far. If it results in a lower harvest, this would have a negative impact on the income of the rural population and its demand for gold. However, physical demand in Asia will not be enough on its own to drive up the gold price. This will require a higher investment demand.
Where do you see the bullion price by the end of 2015?
Following the recent price fall below the important support zone of $1,130-1,140 per troy, it is unrealistic to expect our previous year-end forecast of $1,250 per troy ounce to be realized. In the short term, a further decline towards $1,000 per troy ounce cannot be ruled out. However, we anticipate prices to rise above their current level in the medium to long term. Thus, our year-end estimate stands at $1,150 per troy ounce and at $1,300 for the end of 2016.