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Sharp rally in resource commodities in 2019 on hopes of China demand

Most resource commodities such as crude oil, base metals, steel and iron ore have been rallying since start of calendar 2019, on hopes of rising demand mainly from China. The rally was aided by US Federal Reserve and other central banks turning dovish in tightening monetary policies, and hopes of a resolution in the ongoing US-China trade war.

All major metal and core commodity indices have risen 8-9 per cent since the beginning of the year. Nickel, Zinc, Copper, Tin, steel and iron ore have seen prices rallying from 7-20 per cent, while Brent Crude is up a staggering 26 per cent.

However, the rally seems sentiment-driven and not reflective of realistic market conditions such as slowing global growth. Chances that it will gain more speed depend upon improved global growth. However, analysts don’t see a trend reversal beyond profit booking if the hopes don’t translate into reality.

Kunal Shah, head of research for commodities and currencies at Nirmal Bang securities said, “Sentiment in metals is bullish, contrary to the real state of economies, as global economic growth is estimated to be lower in 2019. However, all major central banks such as like US Fed, Bank of England etc are turning dovish, which is boosting sentiment amid hopes of an early end to the US-China trade war.”

While a formal end to the trade war could see metals rising further, Shah is skeptical of a sustained rally beyond, unless “global economies shows signs of revival.” But he doesn’t see a trend reversal.

A research by S&P Global Market Intelligence data is also supportive of the market. Investments in mining peaked in 2012, following repeated rounds of stimulus and quantitative easing after the global financial crisis. Soon after, mines were globally cutting down production significantly as they didn’t see demand coming, as China started reporting a slower economy. However, S&P has now said that since the past two years– 2017 and 2018–the mineral exploration budget or investment has started rising after a four-year decline.

Mines will put more money in exploration only if they are optimistic about actual demand and price recovery sustaining.

There is another reason why commodities are rising. Early this month, China announced a massive tax relief for its manufacturing sector, cutting the VAT rate by three per cent effective April 1. During the past one year, the VAT rate has fallen from 17 per cent to 13 per cent. This is a big boost for manufacturing, and the metal rally found further strength after the latest announcement.

Sandeep Daga, Director, Regsus Consulting said, “Chinese stimulus is likely to show its colour in the coming months. This is especially important as VAT has been reduced by three percent from April 1.”

Though bullish about a continuous rise in commodity prices, Daga is sceptical about a longer rally. His major worry is that US Fed could start raising rates again.
China’s industrial production, PMI and economic growth data would be crucial to watch.

Daga said Chinese stimulus’ overall impact on business may not be significant and could fade sooner than those in the past. Yet it would lift business and investment sentiments. Perceptions could change from the ‘looming recession’ that existed in the last quarter to ‘euphoric’. This might raise prices in the next quarter.

“Although, we remain bullish on commodity prices for the next quarter, we shall become sceptical of its longetivity if the US Central bank resumes rate hikes. To this extent, one should enjoy the party till it lasts,” Daga said.

Apart from base metals, steel prices have done well on improved demand. That, along with supply disruption in a Brazilian mine, had seen iron ore prices soar. Bernard Dahdah, head of commodity research at London based Natixis said, “Seasonally strong demand, supported by fiscal spending, should draw down on steel inventories and support prices. This will encourage restocking of iron ore in the coming quarter, which combined with the disruption to Brazil’s Vale’s supply, should keep prices above $80/tonne.” He has put a rider that Chinese steel demand should continue, which is uncertain.
Source: Business Standard

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