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The commodity markets: Bear, bull or neither?

Many commodities have been produced in large amounts at an above-market price, with this being particularly true of aluminium, oil, natural gas, platinum and nickel.

However, markets didn’t take notice of this as they were distracted by something else, as markets always are – in this case, US interest rates. We argued that supply rationalisation would follow, as producers wouldn’t remain cash negative forever.

China has maintained a cyclical growth pattern and we had no reason to believe that at the end of last year this would be any different. It was just a deeper cycle exacerbated by the slowdown experienced in the rest of the world.

At the start of the year China opened the credit sluice gates and introduced some supply-side reforms.

The government would cut back on production of oversupplied commodities like coal and steel produced by state-owned enterprises. Private enterprises also reacted by cutting back on smelter capacity in aluminium and zinc.

These coordinated actions jolted the markets into life and the perception of commodity prices declining forever was temporarily forgotten.

Economic realities always prevail, although timing when this will happen is near impossible. Thus we find ourselves at a juncture where some now describe commodities as being in a bull market.

However, we don’t believe commodities are broadly in a bull market based on our fundamental bottom-up research.

We believe there are certainly pockets of interest in the commodity complex, with oil, platinum group metals and copper being the most interesting from a long-term perspective.

Even though iron ore has shot up this year, its longer-term fundamentals look challenged due to lower steel use and production emanating from China.

This year’s runaway price movements were put in motion by last year’s overly pessimistic sentiment.

Chinese housing sales were weak, new housing starts lagged and profitability at steel mills continued to slide. A collapsing iron ore price led to traders holding off on buying new inventory, which led to the shortage at the start of this year when the doom and gloom passed once the government intervened. We believe prices will continue to moderate for iron ore and be closer to $30/ton by 2020.

The fundamentals remained challenged in the short to medium term as China transitions out of its fixed-capital spending phase and into a more service-led economy.

However, some commodities will still thrive in this environment. Thus it’s important to be more selective in this environment and not to expect the entire commodity complex to move in unison.

One should rather attempt to describe each commodity in either a bull or bear market as opposed to taking the lazy route and bucketing them all together.

*This article was originally published as part of the Sanlam Private Wealth collection. Click here for the original version. 

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