Commodity Roundup: February 2015

Commodity prices showed divergent movement in February.

Crude oil prices finally rose in February after 7 consecutive months of decline amid expectations that the recent fall in prices will push high-cost producers of oil out of the market. Already, recent data show that US oil and gas rig count has declined in recent weeks. Consequently, we expect crude oil prices to recover in late-2015.

 

Gold fell 5% in February, following an 8% rise in January. Going ahead, we expect the bearish trend in gold to continue on the back of (1) expected strength in the US Dollar and (2) gold losing its appeal as an inflation-hedge amid low-inflation environment globally. In other development, RBI eased some gold import restrictions, which included removal of the ban on import of gold coins and medallions.

Industrial metal prices fell in February led by declines in nickel and lead. Copper was the exception and rose 7%. However, the move in copper was largely due to value-buying post the 13% fall in January; the LME copper price remains well below USD 6000 per tonne level.

 

Agricultural commodities recovered following the declines in January. Wheat rose 2% following a 15% decline in the previous month.

 

Market Summary

Energy: Crude Oil

Crude oil prices finally rose in February after 7 consecutive months of decline

Review of February: Crude oil prices finally rose after 7 months of decline

Crude oil prices rose in February, following around 7-9% decline in January. The front-month Brent contract rose 14% in the month to around USD 60/bbl, amid expectations that the recent fall in prices will push high-cost producers of oil out of the market. Meanwhile, the North American benchmark, the WTI oil price showed only a muted rise in February (+2%) amid rising US Midwest crude oil stockpiles.

Low oil prices pose risks to US shale and other unconventional oil

US oil and gas rig count has declined in recent weeks

Similar concerns also linger over Canada’s oil sector

Thus, lower oil prices should lead to reduction in the existing surplus in the global crude oil market and gradually move it towards a balanced market

 

Low oil prices pose risks to US shale and other unconventional oil

With Brent currently hovering around USD 60/bbl, oil prices has almost halved since levels seen in July 2014. Lower oil prices pose risks to profitability of new sources of crude oil like shale and oil sands, as these unconventional crude oil have higher costs of production. Recent market reports suggest that costs of production for US shale oil stand in the range of USD 40-70/bbl (with costs varying over different fields). Thus, there remain concerns that investment into US shale oil-sector (and also Canadian oil sands) will slow down, eventually leading to lower oil output from both the countries.

Recent data show that US oil and gas rig count has declined in recent weeks ( refer to chart below). However, US oil production has continued to rise despite the fall in rig count and is at the highest level in at least 30 years. Hence, apparently most of the rigs being recently shut were among the least cost-effective and the most inefficient.

However, concerns remain that lower drilling activity should eventually lead to a slowdown or fall in US crude oil output. Similar concerns also linger over Canada’s oil sector. Hence, there remains possibility that lower oil prices should reduce the existing surplus in the global crude oil market and gradually move it towards a balanced market.

Brent-WTI spread to persist amid stockpile build-up at Cushing

Brent-WTI spread to persist amid stockpile build-up at Cushing

The prospects of deceleration in US crude oil output imply that over time, US will import more oil from rest of the world, thereby reducing the global surplus. However, this has little bearing on the outlook for WTI’s discount to Brent. WTI remains at a considerable discount to the international Brent benchmark as lack of adequate pipeline infrastructure means that a lot of oil is stuck at Cushing (Oklahoma), delivery point for WTI contracts. Consequently, Cushing oil stockpiles have soared ( refer to chart below). Thus, the Brent-WTI spread has widened to ~USD 12/bbl currently compare to USD 1-2/bbl seen in January. The spread should persist as it is unlikely that new pipeline infrastructure will be built in the near-term as the entire energy sector suffers from low investment appetite given the recent fall in prices.

Oil price outlook: Gradual uptick expected in late - 2015

Oil price outlook: Gradual uptick expected in late-2015

As discussed, low oil prices could weigh on investment in US shale and Canadian oil sands, which is expected to reduce the oil market surplus gradually in 2015. Consequently, we expect oil prices to trend higher in late-2015. Meanwhile, Saudi Arabian Oil Minister Al-Naimi recently said that oil markets are returning to “calm” and demand is rising, further supporting our view of gradual price rise.

 

 

Precious Metal: Gold

February was a volatile month for gold

February was a volatile month for gold amid mixed cues on the geo-political front (mainly Greece-EU developments) and the seasonal swing in demand seen in a Chinese Lunar New Year month. The international gold price touched highs of USD 1,270/oz in the first part of February, but subsequently declined to USD 1,200/oz levels.

Gold swung between gains and losses amid uncertainty over Greece- EU relations

Uncertainty over Greece-EU bailout deal kept prices volatile

In the early part of February, widespread concern that Greece would fail to reach an agreement with its creditors spurred gold’s safe-haven demand. However, sentiment improved after Greece and Eurogroup reached an agreement to extend Greece’s loan by 4 months. Consequently, gold prices pared most of their earlier gains.

Early part of February witnessed firm demand from China in the run-up to the Lunar New Year

Seasonal swing in demand owing to Lunar New Year

Gold prices were also supported in the early part of this month amid demand from China and other East Asian countries in the run-up to the Lunar New Year (which commenced on February 19th). However, demand is typically seen to wane once the New Year commences (as most of the buying occurs before), and this may have been another reason for the fall in prices witnessed towards the end of the month.

RBI eased some gold import restrictions, which included removal of the ban on import of gold coins and medallions

Domestic market developments: RBI eases some gold import restrictions

The RBI, on February 18th, permitted nominated banks and trading houses to import gold on a consignment basis. It has also lifted the ban on imports of gold coins and medallions. However, the restriction on sale of gold coins and medallions by banks remains in place. Further, RBI has permitted banks to grant loans against gold to jewellers, which was hitherto banned. These measures are expected to provide some respite to the jewellery industry. Also, with these measures, gold supply through legitimate channels would increase and may therefore discourage illegal inflows.

WGC, in its quarterly publication, reported a decline in 2014 world gold demand by 4%

Meanwhile, India trumped China to emerge as the largest gold consumer

WGC update: World gold demand in 2014 down 4% YoY

According to the World Gold Council (WGC), global gold demand totalled 3,924 tonnes in 2014, down 4% from the previous year. Jewellery demand for the year fell by 10%, largely on an unfavourable base effect (given the surge in jewellery demand in 2013). However, Q4 2014 was a particularly strong quarter, driven by jewellery demand from India and US. Meanwhile, India trumped China to regain its position as the largest consumer of the yellow metal, buoyed by record jewellery demand.

On balance, we expect gold prices to trade with a bearish bias in 2015

Outlook: Gold to trade with a bearish bias in 2015

Gold has erased most of its gains thus far this year, bulk of it in the last week of February. However, much of this was driven by factors which are mostly temporary (like withdrawal of Chinese demand towards end-February). Going ahead, we expect the bearish trend in gold to continue on more fundamental grounds. First, a stronger Dollar and likely rate hike by the Fed in H2 2015 would weigh on sentiment. Second, the low-inflation environment globally is likely to erode gold’s demand as an inflationhedge. However, the downside is likely to be capped in the event of emergence of any geopolitical risks.