Monthly Commodity Update: Commodities in anticipation of Fed rate hikes

by: Casper Burgering , Georgette Boele , Frank Rijkers , Hans van Cleef

In previous periods when financial markets started to anticipate Fed rate hikes, commodity prices did relatively well in the run up to tightening cycles especially commodities with a more cyclical character, such as copper and WTI. This reflects that commodities continue to benefit from a strengthening economy in such an environment. Meanwhile, higher interest rates have generally supported the US dollar and this usually weighed on precious metal prices if sentiment remained constructive. This time around we expect the Fed to increase interest rates by 25bp in December 2016, June and December 2017 in an environment of moderate US growth, with inflation being higher than economic growth. In addition, we expect US real yields to remain low. Therefore, the US dollar is unlikely to rally strongly. These developments will provide support to commodity prices. However, the anticipation of these rate increases could weigh on commodity prices in the near term. As soon as rate hikes are priced in, the impact of the supply and demand fundamentals will take control again. This reflects that commodities continue to benefit from a strengthening economy.

Monthly Commodity Update-Sept-2016.pdf (216 KB)

Energy: Hoping for better days

The oil price will remain volatile over the coming weeks. Our projection for the end of the Q3 remains USD 50/barrel for both Brent and WTI. We see more upward potential for oil prices in the Q4 2016 and 2017. Sustained growth in demand for oil combined with stagnating global production will lead to a better supply-demand balance. Recently, the first clear signal appeared when a report suggested that 2015 oil discoveries dropped to a 70-year low. This suggests that the risk of a supply shortfall has clearly increased. Any anticipation in the market of a structural decrease in the current oversupply – or even a shortfall – will provide support for the oil price. We expect the oil price to rise towards USD 65-75/barrel by 2017.

Precious metals: New gold & silver forecasts

The rally in gold and silver prices is running out of steam as Fed rate hike expectations have resurfaced. We now expect a period of consolidation as long as Fed rate hikes for 2016 and 2017 are not fully priced in. We hold on to our view that the uptrend in gold and silver prices remains in place because of US economic growth will likely be below inflation, US real yields remain low and the long-term US dollar trend has turned negative. However, the prospect of Fed rate hikes will weigh on gold and silver prices and therefore we have adjusted our forecasts. As soon as Fed rate hikes for 2016 and 2017 are fully priced in, we expect gold and silver prices to rally again because of higher demand from investors.

Base metals: Fundamentals will take the upper hand

In anticipation of Fed rate hikes, base metal prices will likely come under pressure. The near-term stronger US dollar – as a result of the rate hike – will make base metals more expensive in other currencies, hurting overall base metals demand. But any time soon after the Fed rate hike, the impact of the supply and demand fundamentals will ultimately take control again. Supply side constraints in zinc and nickel will translate in stronger prices. In aluminium, solid demand will push prices somewhat higher, while overcapacity will hinder significant price increases. In copper, the oversupply will fade, giving space for copper price appreciation.

Ferrous metals: Coking coal prices skyrocketing

Over the past few months, coking coal prices have increased strongly. Since early August, the price for coking coal jumped by almost 63%, reflecting tighter fundamentals. Coking coal output in China fell significantly, fuelling spot market transactions. But at these price levels domestic high cost coal producers in China are likely to increase production again, which will soften prices. At the same time, iron ore prices and steel prices remained stable. Given the relative healthy steel demand outlook going forward and higher coking coal prices, steel prices will strengthen during Q4. However, the gains will be slow given the steel oversupply.

Agriculturals: Fed rate hike adds extra pressure on grain prices

In the past few weeks grains and oilseeds prices came under pressure as a result of supportive weather conditions in important production areas. In combination with high stock levels this results in ongoing price pressures. Coffee prices are rising due to Brazilian cuts in production. Cocoa and sugar prices have stabilised at current high levels as the supply deficit has been widely anticipated. Our expected Fed rate hike by the end of the year will add some extra pressure on prices for wheat and corn.