COMMODITIES OUTLOOK
equities have outperformed commodities, similar to past cycles. Although revenue growth has been relatively muted, margin expansion and expectations for improved earnings growth have boosted equities. Thus far, commodities have been left to deal with the disappointing economic recovery and limited demand growth.
Few Bullish Late Cycle Commodity Indicators Macro fundamentals are finally showing signs of life, especially in the DM. PMI, a common barometer of the manufacturing sector’s economic health, has historically been one of the better leading indicators for commodity prices. In April 2006, six months prior to the commodity boom, the JPM Global PMI Index reached a 19-month high of 55.2. However, while manufacturing has gained momentum as of late, a Feb PMI of 53.3 does not point to robust demand. Most late cycle indicators, namely
goods, industrial production and slowing incremental margins, among others. Improving growth fundamentals coupled with the lack of late
cycle indicators likely put us in the middle of the expansion phase of the GDP cycle, which historically bodes poorly for commodities. Fundamental and structural headwinds only reinforce this view.
A Shift Towards DM Growth Not Helpful for Global Commodity Demand More GDP growth is coming from a re-acceleration in the less commodity-intensive DM. From a headline perspective, this would seem to paint a bearish picture for commodities, all else equal. While this shift tempers our enthusiasm, It does not necessarily make us bearish. EM growth is still outpacing the DM, just by a smaller margin than during prior years. Moreover, base EM demand is much larger than during the last cycle, which suggests absolute EM commodity demand growth can still be quite large despite a smaller headline GDP growth figure (i.e. smaller growth off a larger base). However, DM linked commodities have started to outperform
... the current cycle can be viewed as part of a
“disinflationary boom”, in which global growth gradually accelerates while inflation eases further in the DM
inflation, are yet to be seen as well. Expected inflation
(not realized) is an
almost coincident indicator for commodity prices. Unless EM inflation significantly outpaces expectations, we cannot envision commodities outperforming in a disinflationary environment for DM. Other late cycle indicators to watch for include a rise in capital spending, manufacturing utilization, orders for capital and consumer
DM Expected to Contribute More to Global Growth 2014
(DM and EM contribution to global GDP growth, %)
-3.0 -2.0 -1.0 0.0 1.0 2.0 3.0 4.0 5.0 6.0
2000 20022004 200620082010 DM EM Sources: Morgan Stanley Economics, Morgan Stanley Commodity Research 14 March 2014 2012 2014 3.4%
30.00 35.00 40.00 45.00 50.00 55.00 60.00
20032005 2007 DM 2009 EM 2011 2013
over the past year. This DM performance follows a long period of EM out-performance from the mid-2000s through 2011. Given the growth trajectories of the various regions, we would expect the trend of stronger DM performance to continue. As a result, we view the
setup for commodities linked to EM industrial activity as bearish. Infrastructure
investment in China is likely to decelerate as credit tightens and the government targets a consumer-oriented policy. Base metals were the greatest beneficiary of the EM boom over the last decade and are highly leveraged to any slowdown in fixed asset investment. From a demand perspective, natural gas, platinum/palladium,
refined products/oil, and silver are most levered to a stronger DM. However, the supply story and gas-to-coal switching keep us relatively cautious on natural gas. Supply growth should put some downside pressure on oil as well.
Global PMIs on the Rise, But DM in the Lead
(Aggregated DM and EM Purchasing Manager’s Index)
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