Rocky road ahead for commodities

A combination of monetary policy, currency and weather is set to unleash uncertainty

In many ways, 2017 is likely to be different from the previous years and most likely prove once again that we are living in a VUCA world — volatility, uncertainty, complexity and ambiguity.

The dynamics of the traditional drivers of market — geopolitics, monetary policy, currency and weather — are going to play an important role in impacting commodity fundamentals and, in turn, prices.

Worldwide, commodity market participants are preparing to face a tsunami of events that are set to heighten the risk perception and leave an impact on the marketplace as never before.

The Fed factor first

It could start with the rate hike decision by the US Federal Reserve. At least two, and possibly three, hikes are on the cards. Because the decision is significantly data-driven and data coming out is positive so far (including low unemployment numbers and inflation target), there is widespread expectation of a decision to raise interest rate in March itself. If it does not happen for any reason, then a hike in May or June would seem almost imminent.

This is likely to send the dollar soaring higher as and when the rate hike takes place and will, in turn, cap the upside for commodity prices.

Trump-induced volatility is something most investors are getting accustomed to. The US President wants the economy to grow at 4.0 per cent versus around 2.5 per cent now. He has promised to step up infrastructure investment, which will boost commodity consumption.

To spur growth, tax cuts are on the anvil. Will tax cuts alone drive growth? Experts believe that tax cuts without tax reforms might not bolster growth. Tax loopholes, as also an ageing population, could diminish the impact, it is argued.

Debt ceiling is another contentious issue. How it would be resolved remains to be seen. Its resolution will provide insights on fiscal policy and will send strong signals to equities and bond markets.

Europe, weather factor

Elections in Europe — the Netherlands, France and Germany — this year, coming soon after Brexit last year, have the potential to compound the confusion. How election results will pan out is unclear. The outcome can either strengthen European unity or deepen the divide. Either way, markets will be impacted.

While we are on Europe, it is unclear how long the ECB (European Central Bank) would continue with its ultra-low interest rate regime. There already are signs, albeit incipient, of the economy bottoming out and moving towards the road to recovery. At some stage, the ECB might unwind the accommodative policy. In the event, the euro may strengthen.

Weather risks cannot be ruled out. While La Nina has faded, there are early signs of a developing El Nino. The next two months are crucial.

Barring some aberrations, the world has generally had largely benign weather for four years in a row since 2013. This has resulted in inventory pile-up and softer prices.

However, the agri-food market is vulnerable to weather shocks. The world is just one bad weather event away from a sharp decline in food production and high prices.

China watch

Uncertainty relating to the outcome of many of the aforesaid events is sure to cast a long shadow on commodity production, consumption and investment during the year. China will be closely watched.

While slowing China has been a matter of concern, it is important to remember that the Asian major is slowing from a high base. Industrial commodities that are growth-driven have the potential for price gains. Energy and select base metals come in this category.

While OPEC-driven agreement on crude oil production cut has sent prices higher (around $55 a barrel), the upside risk is largely contained by rising shale oil output in the US.

Indeed, the rig counts are rising and the price impact of OPEC decision to cut output will be largely muted in the coming months. Yet, the world has to brace itself for volatility in oil prices in the months ahead.

Logically, market uncertainties should push gold prices up. However, the yellow metal is facing its own set of challenges. The primary challenge is weak demand in two of the world’s largest importers and consumers, India and China.

Central banks’ gold buying spree might wind down. The strong possibility of two or three Fed rate hikes is sure to take the sheen off gold this year.

The author is an Agribusiness and Commodity Markets specialist

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