The global economy does not look any better than it did in 2016, which should remain the main concern for the commodity sector
At the start of 2016, the commodities sector inspired pessimism with most forecasts warning of dire times for metals, especially steel, and crude oil.
As the year draws to a close, commodities have done much better than anyone expected, with the Bloomberg Commodities Index returning a gain of 10%. The sub-index of industrial metals returned 23%. Crude oil gained 21%. Forecasts for 2017 now talk about good times for commodities.
At the start of the year, several things were worrying commodity watchers. An end to quantitative easing and rate hikes by the US Federal Reserve was one. The Fed had hiked rates in December 2015, but it held fire all through 2016 and raised rates only once, in December. It had hinted at a slow but gradual increase in rates.
The yuan’s devaluation was another concern, particularly for India, as this made Chinese exports cheaper. The dollar’s strength too was a worry, as this was expected to see funds shift the focus away from commodities. Another problem was China’s intention to shift the economy’s growth away from an investment-led model to a consumption-led one, along with a soft landing. Even this did not play out as expected, and China’s appetite for commodities did not wane. Its appetite for iron ore, for instance, supported a rapid rise in prices.
Commodity producers also limited supply—a major contributor to firm prices. They temporarily shuttered plants that were not viable or even closed them down. The effect was to tighten supplies. China too asked polluting old industries to shut down, which also meant capacity cuts. Recently, oil producing countries agreed to output cuts to support crude oil prices.
Since the going in 2016 was better than expected, the glow from rising commodity prices may tempt one to remain bullish. But what are the risks? Losing production discipline is one. The increase in crude oil prices, for instance, hinges on the producing countries limiting output as promised. The sharp increase in metal prices could see restarts of shuttered plants, which could upset the demand-supply balance.
The US Fed has guided for further rate hikes in 2017. If the data supports the case for a rate hike, then 2017 may be different than 2016. That could cause some upheaval for commodities. A strong US economy could mean higher demand for commodities too. China can surprise on the downside. The global economy does not look any better than it did in 2016, which should remain the main concern for the commodity sector. If that outlook changes for the better, then the odds of commodities doing well in 2017 improves.
This matters to India. A sustained increase in commodity prices can add significantly to cash flows of producers. That is not only good for their valuations but also improves their ability to service debt and potentially lower the banking sector’s burden of non-performing assets.
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