- Individual commodities trade on their own fundamentals.
- Near-term pressure on gold and silver to give way as inflation rises faster than interest rates.
- Oil to continue range bound trading in first half until visible signs of production cut-backs emerge.
- Short-term correction in industrial metals to precede gains, while La Niña to place pressure on agricultural prices
Commodities to trade on own fundamentals
While many group commodities as one asset class, in reality each commodity trades on its own fundamentals. Historic correlation between commodities has been relatively low. In this outlook we will provide an overview of our views on major commodities within each sub-category.
Gold and silver: near term pressure, medium term strength
We believe the US Federal Reserve (Fed) is still on track to raise rates in December 2016. Although there was a degree of political uncertainty in the run-up to the Presidential election, Trump’s progrowth policies are likely to be inflationary. In the short-term, gold and silver prices are likely to come under pressure as we approach the rate hike. However, we believe that the Fed will remain behind the curve and inflation will rise faster than the central bank will raise rates, keeping real rates very low. According to the Fed’s latest ‘dot-plot’ of its committee member’s assessment of appropriate policy settings, the Fed is only likely to raise rates twice in 2017. Low real rates are gold price positive. We believe that gold’s fair value is between the $1400-1450/ounce range.
Silver has a close correlation with gold and hence we expect silver prices to rise. In contrast to gold, which trades like a currency, the physical supply and demand for silver also drives the silver price. Factoring in the decline in mining investment and rising industrial activity, we estimate silver’s fair value in the $22-24/ounce range.
Speculative positioning in gold and silver has retreated from highs reached in July, but they remain elevated as investors seek a hedge against geopolitical risk. The Italian constitutional referendum, the French Presidential election and the German parliamentary elections are some of the items on the calendar for the coming year. When and if the United Kingdom (UK) will start the process of leaving the European Union (EU) has still not been resolved. Rising populism poses a threat to stability and investors will look to hedge this risk.
Oil market still on path to balance
We believe that oil will continue to trade in the $40-55/bbl (barrel) range until visible signs of a production cut-back emerge. The market is coming closer toward a supply-demand balance, but the path will be bumpy. Close to $1 trillion of investment cuts in the oil and gas industry since the start of the oil price crash that began in November 2014 will start to bite into supply in 2017.