The US Federal Reserve has said it will continue with its monthly bond-buying programme (quantitative easing or QE), boosting investor sentiment worldwide because the liquidity tap remains open for now.
What does this mean for commodities, especially metals? Easy liquidity conditions had propped up commodity prices, even when economic conditions were turning weak. But the potential threat to liquidity, from a Fed taper, had resulted in commodity prices retreating after May. This was particularly visible in non-ferrous metal prices. But prices have recovered since August despite the threat of a tapering due to improving economic conditions in parts of the world.
Developed economies such as the US and the UK are seeing signs of a pickup, and green shoots of an economic revival are visible in the euro zone as well. Even a small but sustained economic recovery in these large economies can have a sizeable impact on the global commodity market.
The Chinese economy, too, has been recovering, though it does appear that the state may again have a role in spurring investment-led demand, rather than consumer-led demand that it was hoping for. China is both a large producer as well as consumer of commodities, and a recovery in its economy can boost prices. The increase in commodity prices in August coincided with the Chinese manufacturing purchasing managers index rising for the first time since April.
Conditions are thus becoming favourable for an increase in commodity prices. Rising prices can benefit Indian firms, but a stronger rupee makes imports cheaper. Companies, therefore, need commodity prices to increase in rupee terms for them to benefit. Cheaper imported energy costs could be a positive because of a stronger rupee, unless coal prices rise sharply.
Price realizations are no doubt important, but the domestic monetary policy stance —under the new governor—may play a more important role. An improvement in domestic liquidity conditions and a decline in interest costs will make it easier to do business.
A pickup in India’s economic growth can lend support, too. Consumption demand has to improve so that investment demand revives eventually. Both factors together can drive higher demand for commodities.
This path to a revival for the commodity industry is likely to be marked by volatility and investors should not lose sight of that. The Fed has only postponed the tapering, giving emerging economies such as India a little more time to get their act together.