SOURCE: Scotiabank

Scotiabank

January 28, 2014 07:00 ET

Scotiabank's Commodity Price Index: 2013 Was Weak, but U.S. Growth Is Promising

TORONTO, ON--(Marketwired - January 28, 2014) - Scotiabank's Commodity Price Index ended 2013 on a weak note, falling -1.2% month over month (m/m) and dropping 6.8% compared to a year ago, the second consecutive annual decline. All sub-components lost ground in December. 

"Signs point to a bottoming in the All Items Index in early 2014," said Patricia Mohr, Scotiabank's Vice President of Economics and Commodity Market Specialist. "Prospects for stronger U.S. economic growth (about +3%), with China's Gross Domestic Product (GDP) still likely to advance by more than 7% this year, should provide a modestly positive backdrop for commodity markets."

Highlights in the report include:

  • The correction in metal and mineral prices is almost over, with gold likely touching bottom in late June 2013;
  • Potash prices are steady, as Uralkali concludes a higher-than-expected contract price with China;
  • Copper prices rally in late 2013 and early 2014, with rumours that China's State Reserve Bureau may step-up strategic purchases;
  • Indonesia goes ahead with export ban on unprocessed nickel ores and bauxite, pointing to a gradual recovery in nickel prices; and
  • The discount on Western Canadian Select (WCS) heavy oil widened to an enormous US$39.13 per barrel off West Texas Intermediate (WTI) oil in December, but will narrow to US$19.12 in February, partly due to start-up of the long anticipated new coker at the BP Whiting, Indiana refinery, upgraded specifically to process cheaper heavy oil from Canada. 

Read the full Scotiabank Commodity Price Index below, and view the report, with charts and graphs, at http://www.scotiabank.com/ca/en/0,,3112,00.html.

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Commodity Prices Approach Bottom

Scotiabank's Commodity Price Index ended 2013 on a weak note, falling -1.2% month over month (m/m) and -6.8% below a year ago -- the second consecutive annual decline. All sub-components lost ground in December. 

However, signs point to a bottoming in the All Items Index in early 2014. Prospects for stronger U.S. economic growth (about +3%), with China's GDP still likely to advance by more than 7% this year, should provide a modestly positive backdrop for commodity markets (despite the lower Flash HSBC-Markit Purchasing Managers' Index for China's manufacturing in January). Growth in the global manufacturing sector in late 2013 posted its best performance since 2011:Q2 -- led by an improvement in the G7 -- boosting base metal orders and local price premia. Moreover, the correction in metal and mineral prices is largely over, with gold likely touching bottom in late June 2013, prospects beginning to improve for potash and Japan likely to restart at least some of its nuclear reactors (utilities have already applied for permits to restart 16 of 50 reactors). Nickel prices have also edged up, after Indonesia implemented a January 12 export ban on unprocessed ores. 

In December, the Metal and Mineral Index lost further ground, -0.9% m/m and -18.2% year over year (yr/yr). Gold prices corrected again mid-month, following the Fed's December 18, 2013 announcement that it would reduce its 'asset purchase program' -- the monthly purchase of mortgage-backed securities and longer-dated Treasury bonds -- by US$10 billion to US$75 billion beginning in January. However, gold held its ground just above the previous low of US$1,180 -- reached last June after the Fed Chairman initially announced that quantitative easing would likely soon be tapered, employment and economic conditions permitting. 

While gold is vulnerable to further rounds of Fed tapering through 2014 (that is, reduced liquidity), chances are good that gold has bottomed. The US$1,180 level is close to the 2013 all-in sustaining cash costs of 20% of the world's highest-cost gold producers; even with sharp cost-cutting, lower prices of about US$1,050, if sustained, would likely trigger mine production cuts. Gold is currently trading at US$1,261 (bid as a 'safe-haven' amid fresh emerging-market concerns) and should rally to US$1,375 in 2015, on prospects for higher inflation in the second half of the decade. 

Partially offsetting softer precious metal prices in December was a strong rally in base metals. London Metal Exchange (LME) copper ended 2013 on a strong note at US$3.26 per pound and has climbed further to US$3.32 so far in January. Copper remains one of the most lucrative of all commodities, yielding a 30% profit margin over average world breakeven costs including depreciation. A rumour that China's State Reserve Bureau might buy 300,000 tonnes of copper in 2014, believing prices to be near a cyclical low, would wipe out this year's projected 'surplus' and has lifted sentiment. Actual supply and demand conditions were firm in late 2013, given the strength of China's underlying copper consumption, which accelerated by 12% in 2013, and a shortage of copper scrap. 

The Oil and Gas Index also declined in December (-1.1% m/m), as the discount on Western Canadian Select heavy oil (WCS) widened to an enormous US$39.13 off WTI oil. However, the discount narrowed to US$29.22 in January and US$19.12 in February, partly due to start-up of the long anticipated new coker (102,000 b/d) at the large BP Whiting, Indiana refinery (413,000 b/d), upgraded and expanded specifically to process cheaper heavy oil from Canada.

Also on a positive note, the energy sub-index ended the year up 5.5% over a year ago. Propane prices at Edmonton and Sarnia surged to an average of US$67.94 per barrel in late 2013 (+117% yr/yr) amid strong heating and petrochemical demand in Canada and the U.S. (Keyera and Pembina). In the U.S. Midwest, large volumes of propane were used to dry a record, late harvest of corn last fall, setting the stage for tight supplies of the heating fuel given this winter's frigid temperatures (especially in Michigan and Ohio, where shortages have emerged). Fourteen million households in the upper Midwest use the liquefied gas to heat homes. Rising offshore sales from the U.S. Gulf Coast (Texas) -- a new feature of the market -- have had a ripple effect across North America, tightening supplies. 

Canadian natural gas export prices increased to US$3.67 per thousand cubic feet (mcf) in 2013 (US$3.92 in December) -- a big improvement from only US$2.84 in 2012. The coldest winter temperatures in almost two decades in the U.S. Midwest and New England propelled Nymex prices to US$5.18 per one million British thermal units (mmbtu) on January 24 (the highest since June 2010), with a record drawdown of U.S. gas-in-storage this heating season (-1.356 billion cubic feet). U.S. inventories are 13% below the 5-year average. While ample supplies are waiting in the wings for development, given the shale revolution, low inventories going into the summer cooling season will underpin prices at higher-than-previously forecast levels. 

The Forest Products Index also lost ground in December (-2.1% m/m), but remained slightly above a year earlier (+0.1%). Western Spruce-Pine-Fir 2x4 lumber and OSB prices lost ground seasonally, with lumber falling from US$382 per thousand board feet (mfbm) in November to a still profitable US$364, as snow cover inhibited building activity. However, prices have edged up again to US$376 in mid-January. We remain optimistic that prices will strengthen further to average US$390 in 2014 alongside a multiple-year recovery in U.S. housing starts. Northern bleached softwood kraft (NBSK) pulp prices in the U.S. market -- important to the B.C. and Eastern Canadian economies -- were flat in December at US$990 per tonne, but increased another US$20 in January to a lucrative US$1,010 -- a 2½ year high (annual discounts off list will increase 2-3% in 2014). Low world inventories of softwood kraft (only 25-days of supply) contributed to the price increase. 

Finally, the Agricultural Index fell back further in December (-1.3% m/m and -13.4% yr/yr). No. 1 grade canola (FOB Vancouver) retreated from US$488 per tonne in November to US$447 in December and US$420 in mid-January (-35% from the extraordinary heights of early 2013, but still above the US$378 average of 2000-13). The December 4 post-harvest survey from Statistics Canada revealed a much bigger canola crop than expected -- a record 18 million tonnes, up from 13.9 million tonnes the year before. Significantly lower canola prices also reflect ample world supplies of vegetable oils, partly linked to stepped-up output of palm oil by Malaysia/Indonesia, and limited rail cars in Canada to move the massive crop to the B.C. Coast for export. A higher ending stocks-to-use ratio for canola at 19% in 2013-14, than for U.S. soybeans at 5%, accounts for the recently bigger decline in canola than Chicago Board of Trade (CBOT) soybean prices, despite the healthy food attributes of canola. Barley prices at Lethbridge also lost ground in December (a benefit to livestock producers), though wheat prices rallied. 

Materials Set To Bottom in 'China's Year of the Horse'

Spot potash prices (FOB Vancouver) edged down further from US$320 per tonne in November to US$305 in December. However, three developments point to steadier market conditions ahead:

1) Uralkali has concluded a higher-than-expected 2014:H1 contract price with China at US$305 (delivered) -- likely setting a floor for prices; (some observers had feared a price below US$300); Uralkali is also seeking a US$40 increase to US$350 for granular prices in Brazil beginning in March;
2) signs point to a rapprochement between Uralkali and Belaruskali, following the acquisition of a 20% equity stake in Uralkali by UralChem and a CEO appointed at Uralkali, with possible restoration of a marketing arrangement in 2014; and
3) Canpotex entered into a one-year memorandum of understanding (MoU) to supply one million tonnes of potash to Sinofert -- its exclusive agent in China -- for 2014. While a price has not been announced, the US$305 contract between Uralkali and China is likely indicative. 

While prices should steady and shipments pick up in 2014:H1, a significant price recovery likely awaits the second half of the year. Nevertheless, equity valuations for Canadian and Chilean potash producers have rallied significantly in early 2014.

Turning to base metals, LME zinc prices strengthened to US$0.89 per pound in December and have moved up further in January to US$0.93. We continue to believe zinc will be the 'next big base metal play' for investors, with prices climbing to US$1.30-1.40 in 2015. Our reasons are two-fold: 1) Gains in world mine production over the next 4-5 years will likely fall behind global demand growth (4.7% per annum from 2012-17), given unusually high depletion at major mines in the face of tighter capital availability for new mine development; Century in Australia will close one year early in mid-2015 (515,000 tonnes per annum) and Lisheen will shut in 2015 (172,000 t/a), following closures in 2013 at Brunswick (190,000 t/a) and Perseverance (125,000 t/a) in Canada; and 

2)  The major end uses of primary zinc in galvanized steel are picking up – particularly in motor vehicle production and construction. World vehicle sales reached a record high in 2013 of more than 81 million units and an even bigger record is forecast for 2014 at almost 86 million (+5%). China's car and cross-over utility sales jumped by more than 20%, surpassing U.S. sales last year, and should advance another 12.5 % in 2014. U.S. non-residential construction, a sector which has struggled since 2008, also appears to be turning around (especially in office buildings). A broader turnaround in non-residential construction is expected across the G7 in the second half of the decade.

LME nickel prices have also edged up, following Indonesia's January 12th ban on exports of unprocessed nickel-containing ore. China unnerved the nickel market last year by maximizing its imports of Indonesian ore for nickel pig iron (NPI) production, ahead of the ban. While prices have only inched up to US$6.47 per pound, market conditions should tighten further by late 2014-15, once China uses up inventory on hand (estimated at 7 months' supply). Indonesia currently accounts for 28.2% of world nickel mine supplies. (While Indonesia will permit the continued export of copper concentrates until 2017, e.g. from Grasberg and Batu Hijau, the export tax has been increased from a notional 20% to 25% in 2014 and ultimately to 60% by 2016:H2. Grasberg and Batu Hijau could be exempted -- as in the past -- under their Contracts of Work.) 

Changing North American Oil Industry Dynamics 

The U.S. oil industry has reached a number of major milestones in the past year, with crude oil production in November climbing over 8 million barrels per day for the first time since 1988 and net refined product exports increasing by 817,000 b/d, year to date, making the U.S. one of the biggest net product exporters in the world -- contributing to recent U.S. dollar strength. With 2014 expected to be another year of remarkable growth in U.S. 'light, tight oil' output, leading to wider discounts on WTI vis-a-vis Brent, U.S. policy makers are debating whether the ban on U.S. crude oil exports should be lifted. Department of Commerce licenses are routinely obtained for exports to Canada and North Slope Alaskan crude has been exempt under separate legislation.)

In Western Canada, oil production should climb by another150-200,000 b/d in 2014, centred in Alberta bitumen projects, which are quite cost competitive. New rail loading terminals (operated by Canexus, TORQ, Gibson and Keyera/Kinder Morgan) should help to deliver this heavy crude to US Gulf Coast and Midwest refineries, recently reconfigured to run cheaper heavier feedstocks.

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