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February 07, 2020 | 14:22
Coronavirus Adds to Commodity Headwinds
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Coronavirus Adds to Commodity HeadwindsCarl Campus, Aaron Goertzen, Sarah Howcroft and Art Woo |
Commodity markets entered 2020 with some cautious optimism, buoyed by the Phase One trade agreement between the U.S. and China and firming economic signals. However, the backdrop abruptly shifted in recent weeks as the outbreak of the Wuhan coronavirus has dashed hopes for a strong turnaround in global trade and industrial activity, sending oil and other commodity prices tumbling. We anticipate the health crisis will be a high-impact but short-lived event, resulting in a steep deceleration in China’s yearly GDP growth pace in Q1, followed by a modest rebound in Q2. Until the virus’ spread is contained, the shock will reverberate around the world economy, disrupting travel and manufacturing supply chains, with material downside for Asian countries dependent on China for trade and tourism. While the situation clearly remains fluid, we have adjusted our price forecasts for some commodities in light of the expected fallout. Base metals have taken a hit, though should recover in time as economic activity resumes, especially if the Chinese government opts for an investment-heavy stimulus response. Gold, on the other hand, has remained well-supported by the flight to safety and drop in Treasury yields. The path for oil prices, which plummeted by roughly 20% over the last month, will hinge on whether OPEC+ production cuts are reinforced. The following is our updated outlook for various commodities segments over the next two years. Energy: As China is the second-largest consumer of oil (at 13.6 mbbl/d or 13.6% of the world total in 2019) and the main driver of global demand growth, the abrupt downturn in its economy has altered the overall supply/demand balance for crude oil. Thus, the two big questions facing the oil market revolve around the degree of decline in global demand and the impending supply-side response from OPEC+. Forecasting the former is difficult at present given the uncertainty over how the outbreak will evolve. More importantly, OPEC+ appears ready to deepen and extend its current output cuts of 2.1 mbbl/d (expiring at end-March) to offset weaker China demand, and is reportedly considering an additional cut of 600k bbl/d. Beyond the additional pressure from the coronavirus, OPEC+ will likely need to continue restraining supply given the subdued global economic outlook and risks associated with rising non-OPEC+ production. Equally important, Saudi Arabia, the world’s key swing producer, appears highly committed to ensuring prices do not fall given its weak fiscal situation. As a result, we expect the price of crude oil to recover as the impact of the coronavirus dissipates and are maintaining our full-year average projections for WTI at US$57 for both 2020 and 2021, within OPEC+'s perceived comfort zone of $55-60. North America's natural gas market has been largely unaffected by the outbreak. However, benchmark Henry Hub has been struggling, which led us to revise down our forecast recently to an annual average of US$2.25/mmbtu for 2020 and $2.50 for 2021. Beyond warmer-than-normal temperatures, the key reason for the revision is the likelihood that growth in U.S. natural gas production will outpace consumption by a wide margin due mainly to higher associated gas production from oil-directed rigs and increased pipeline capacity. Metals: Portfolio allocation was a major catalyst for gold last year amid weak economic growth, declining global bond yields and heightened geopolitical risks. Accelerated central bank buying provided an additional boost, helping to compensate for the drop in consumer demand for gold bars and jewelry. Notwithstanding the cooling in trade tensions, safe haven demand remained strong in the opening weeks of 2020 following the spike in U.S./Iran hostilities and, subsequently, the coronavirus outbreak. While easy global monetary conditions will remain broadly supportive in 2020, gold is unlikely to sustain its current altitude, assuming the virus can be contained in the near term without any major disruption to global growth. We expect the yellow metal to average US$1500 in 2020 (up from $1393 in 2019), pulling back to $1450 in 2021 as global growth and bond yields recover. After a difficult year marred by the global growth slowdown and ever-present trade friction, base metals are now facing another setback from the coronavirus. Given China’s role as both the largest and marginal consumer of most base metals, prolonged factory shutdowns and travel restrictions will have an acute impact on demand in Q1. The Chinese authorities will continue to provide monetary and fiscal support to ensure the economy regains its footing once the outbreak is contained (recall, President Xi’s pledge to double 2010 per capita GDP by 2020); however, the hit to confidence may take longer to dissipate. Meanwhile, other key emerging markets (e.g., India, Brazil, Mexico, South Africa) continue to face their own growth and structural challenges, adding to base metals’ woes as global demand is increasingly dependent on these economies. On balance, we continue to anticipate higher average base metals prices in 2020-21 as the global macro environment gradually improves, but we have marked down our 2020 price forecasts for copper, nickel and aluminum. Forest Products: The forest products segment has entered 2020 on a more solid footing as substantial capacity reductions over the past year have helped correct prior market imbalances. At the same time, home building, a primary catalyst for lumber and panelboard pricing trends, has experienced renewed strength amid improved housing affordability (via lower mortgage rates) and persistent labour market strength. While rising housing sentiment has helped offset some of the drag from whipsawing global trade tensions, lingering USMCA implementation uncertainty and the softwood lumber dispute, home builders continue to face several obstacles preventing a significant upswing in residential construction, such as high building material costs, scarcity of lots and labour shortages. As such, U.S. housing starts are expected to rise to just 1.35 million units in 2020—well below the prior cycle’s high of 2.07 million units—even with homebuilder sentiment near a two-decade high. Additional challenges include the shrinking share of single-family homes (which use three times more lumber than multi-unit dwellings) and smaller build sizes. Furthermore, growth in U.S. existing home sales is expected to be relatively subdued over the forecast period, constraining lumber demand given its correlation to other major end-uses such as renovations and home furnishings. As such, our base case calls for Spruce-Pine-Fir (SPF) lumber to average US$360/mbf in 2020, matching the 2019 average, before dipping modestly to $355 in 2021. Agriculture: Though they trended higher in the latter part of 2019, crop prices remain low by historical norms, primarily due to persistent excess supply. Indeed, global wheat production is expected to reach a new high during the current marketing year, despite growing challenges in some regions (i.e., Black Sea and Australia), given generally solid yields elsewhere and a particularly strong crop in Europe. As a result, global stockpiles are expected to remain near recent highs relative to consumption. The demand environment has also deteriorated somewhat, given the subdued pace of global economic growth and more moderate food consumption growth in the United States. Overall, wheat prices are expected to increase from an average of US$4.94/bushel in 2019 to $5.50 in 2020 and 2021. In addition to oversupply concerns, North American oilseed prices have also been undermined by the U.S/China trade war, which has resulted in soybean stockpiles sitting far above recent norms. While China has agreed to ramp up its purchases of U.S. agricultural products as part of the Phase One trade deal, the coronavirus crisis will make it difficult to deliver on specific commitments. Making matters worse, African swine fever (ASF) continues to ravage the hog herds of China and other Asian countries, reducing their need for feed products like canola. Assuming that U.S./China trade relations remain on track and China is able to begin rebuilding its hog herd, canola prices are projected to modestly advance from US$344/tonne on average in 2019 to $375 in 2020 and $400 in 2021. |
Livestock prices demonstrated substantial volatility in 2019. The hog market was walloped by the spread of ASF, which is estimated to have resulted in the destruction of 40% or more of China’s world-leading hog herd. Unfortunately, global trade tensions prevented Asia’s pork shortage from providing much upside to North American hog prices, and notwithstanding the Phase One deal, the market remains cautious amid rapidly increasing U.S. supply. Although per-capita pork consumption in the U.S. has also been rising, the industry will almost certainly need an external outlet for surplus production. If China is able to meaningfully expand its imports of U.S. pork, benchmark hog prices should increase from an average of US$70/cwt in 2019 to $75 in 2020 and $80 in 2021. Cattle prices trended down throughout most of 2019, reaching new lows in September after a fire temporarily disabled a massive meatpacking plant in Kansas. Now that the plant is back online, cattle supply and demand are fairly balanced, with herd expansion proceeding at a relatively prudent pace and rising per-capita beef consumption helping to absorb the increase in domestic production. Overall, cattle prices are expected to increase from an average of US$116/cwt in 2019 to $120 in 2020 and $122 in 2021. For further details, read the January 2020 issue of our monthly commodity report, The Goods. |
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