Macquarie's economists are turning more pessimistic.
In their latest Global Macro Outlook note, the Australian bank warns that the global economy's recent "coordinated" growth has peaked, which will have implications for all asset classes. In this note we look at their forecast for the commodity sector, where Macquarie is especially gloomy, warning that "the supporting factors for wider commodity markets are now being steadily eroded" and adds that "hopes for accelerating global growth and accompanying healthy reflation are fading. The industrial recovery cycle has matured, and is providing less global impetus."
A key culprit behind the upcoming slowdown is predictably China:
After the regular liquidity pushes of 2016, the Chinese government has now shifted to a tightening bias, propagating a destock cycle through the manufacturing chain. Chinese construction activity has been extremely strong, but we also expect sequential weakness in this area. To be clear, underlying demand conditions are and still will be good over the coming months even if the global industrial growth cycle has peaked, but sentiment shifts are clearly now on a downward trend given previously high expectations.
Furthermore, the bank warns that "things were too good to be sustainable earlier in the year, with many commodities trading out of cost curves. Cyclically, that means commodity positioning should be generally defensive, with even those commodities having raw material constraints under pressure. But as the reflation tide goes out, it gives an opportunity to discern which commodities genuinely have strong fundamentals. Structurally, it is a time to start picking longer-term winners."
And so, once again we go to the credit impulse and the (re)flation cycle, which has in recent years originated almost exclusively in China.
So what does that mean from a commodity cycle standpoint: as Macquarie notes, demand leads and supply reacts, with a lag. And the factor which facilitates this process is price.
2017 looks to be providing another classic example of this simple commodity rule, one we have seen played out again and again. Those which traded out the cost curve in 2016 are seeing the strongest positive supply reaction (before disruptions), and those which have consistently traded into the cost curve a supply decline in the main. Coming months will find out the extent to which supply-side flexibility exists across various commodities.
Below we present some further observations from the Macquarie commodities team:
Over the coming months, commodities as a whole look set to face slightly more headwinds than tailwinds. We would avoid those most exposed to Chinese construction, given it is currently so strong that the next move is likely to be lower. This means further pressure on iron ore, metallurgical coal and manganese. In contrast, we expect upside to gold and silver over the coming months as the market refocuses from healthy reflation to deflation potential. We also believe the wider market has become too sanguine to weather risks in agricultural markets, where we feel risk/reward is skewed to the upside.
We would also consider optionality around those commodities where the Chinese government is set to curtail capacity. Aluminium has been widely discussed in this regard, but we would also look at stainless steel, nitrogen and alumina as those with potential to be next on the supply side reform agenda.
On a longer-term view, we like exposure to copper, silver, gold, chrome and, eventually, oil. We also believe that uranium and potash are at the start of a long crawl off the canvas after a tough couple of years.