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Lower demand for commodities leads to higher commodity prices?

  • Viola Caon
  • 28 May 2014
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Koen Straetmans, senior Multi-Asset strategist at ING Investment Management International (ING IM) looks at what the missing elements are.

Koen Straetmans, senior Multi-Asset strategist at ING Investment Management International (ING IM) looks at what the missing elements are.

China is the dominant consumer of commodities in the world, representing 40% of demand for industrial metals. Therefore, an economic slowdown in China should exert downward price pressure on commodities.

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That is only part of the story, however. In early 2014, commodities were at the top of the performance table for asset categories whilst the growth slowdown in China is common knowledge.

Koen Straetmans, Senior Multi-Asset Strategist at ING IM starts: “Two factors have played a specific role in the pricing of commodities this year: weather patterns and geopolitical risk.

“Firstly, there was a polar vortex, bringing extreme cold to the US during the winter. This pushed up the prices of US gas spectacularly, despite the prospect of further large-scale exploitation of shale gas reserves.

“When this cold spell continued into the beginning of spring, resulting in continuing high demand for gas, and with the difficult resumption of gas production after the freeze-offs, gas prices remained higher than would generally be expected in a seasonal phase of gas inventory replenishment.”

On agriculture, Straetmans comments: “This cold also pushed up US winter wheat prices, delaying harvest and planting of new crops (soy), in turn increasing uncertainty as to the new harvest. On the whole nevertheless, US maize and soya harvests are currently still expected to be good.

“Drought and cold also prompted good performance from the Livestock segment, resulting in low cattle inventories. In addition, pig stock was affected by a virus, resulting in a reduced demand for grains and soya meal.
“

At the same time, a major drought in Brazil jeopardised the coffee and soya bean harvest. As a consequence, by April coffee prices had risen by more than 80% since the beginning of the year.”
Straetmans continues, commenting on his second factor, geopolitical risk:

“The most striking development so far this year was Russia’s invasion of Ukraine. The resulting threat of economic sanctions (primarily by the US) supported crude-oil prices (Russia is the top producer) at a time when demand generally diminishes as a result of refinery maintenance after the winter.

“It also compensated for the expected reduced demand for oil from China (China remains the major contributor to the ‘growth’ in the global demand for oil). Similarly, the Russian invasion also boosted maize and wheat prices, as Ukraine is the third largest maize exporter and the sixth largest wheat exporter in the world.

Straetmans concludes: “Geopolitics and weather are omnipresent in the commodities world. For investors, it sometimes pays to capitalise on these risks.

“The growing risk of an El Nino weather pattern is such an example. El Nino typically causes drought in Southeast Asia / Australia and extreme rainfall in the West of Latin America, which tends to jeopardise the wheat harvest (Australia) or sugar production (India). Mines can also flood (zinc mines in Peru). An El Nino basket for a possible extreme weather pattern can then be a good supplement to the commodities portfolio.”

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