COMMODITIES OUTLOOK
Consumption-Linked Demand Could Prove More Resilient Relative positioning may favour consumption-linked commodities over industrial commodities. As the EM rebalances, we expect a gradual shift from industrial/investment driven growth towards domestic consumption. Although a higher reliance on internal consumption could slow EM exports and lift imports, putting pressure on headline EM GDP, such a shift might simply swing the mix of commodity demand rather than restrain total demand. Distinguishing by end market exposure is complicated because
some commodities (i.e. crude oil, copper and lead) are linked to both consumer and industrial activity. Grains, livestock, and softs are almost entirely consumer driven, while energy and base metals have ties to both markets. Heating oil, gasoil, zinc and the bulk commodities are strongly associated with industrial activity. Many base metals also have a heavy industrial or infrastructure demand component. Under this lens, refined products, platinum and palladium appear well positioned given stronger consumer demand. The consumer-heavy DM is re-accelerating, and even in a slower growth environment, EM consumption should continue to grow. Lower prices could stimulate demand in EM, especially for the more price-elastic commodities like precious metals and the softs.
USD Appreciation a Potential Headwind For Commodity Prices in 2014 Morgan Stanley’s FX strategists see broad USD
strength in 2014. Further Fed tapering coupled with a rebound of the US economy should reverse capital outflows, pushing the USD higher in 2014. The EUR/USD is expected to trade down to 1.24 by year end with the DXY rising to almost 87. Morgan Stanley expects EM currencies to depreciate 6% in their base case. Our FX strategy team expects EM currencies to face more pressure in 2014 on the back of deteriorating terms of trade for commodity exporters and a myriad of domestic issues (rising inflation, a growing debt burden, and an uncertain political landscape). BRL, IDR, and RUB will be most challenged in this regard. However, the magnitude of the USD headwind may be
seems much more restrained relative to the last cycle. After the run-up in prices during the 2000s, supply growth has responded. While the elasticity of supply to changes in price varies by commodity, enough time has elapsed since the boom of the 2000s that we are seeing some response across all commodities. Even traditionally inelastic commodities
like copper and oil are experiencing supply growth. Historically, supply of crude oil, gold and copper has responded to price, but that response is often muted by long lead times (as much as 1-3 years) and difficulties in bringing on new supply. However, at this point, multi-year strength in both oil and copper prices have brought about large-scale increases in supply in the form of the shale revolution and new copper mines. This supply growth will likely challenge an
otherwise improving global demand outlook. The large supply gains in many commodities
Commodities Tend to Be Negatively Correlated with USD
(Left axis: S&P GSCI spot return index; right axis: DXY spot index)
200 300 400 500 600 700 800 900
Jan-05
overstated. Dollar appreciation is generally considered a major headwind across the commodity space given that most commodities are priced in US dollars. However, exposure varies widely by commodity, and a dollar rally in response to a strengthening US economy could actually prove to be a bullish signal for commodity demand. At a minimum, we do not expect the large USD betas of the past 5-years to continue. As of late, USD betas have generally been compressing across the complex. USD betas for Brent and WTI, which have historically been greater than -1, fell well below -0.50 in 2013 – suggesting these commodities haven’t been as responsive to fluctuations in the dollar. Natural gas, soybeans, corn, and live cattle even had positive betas last year.
Supply Growth More Challenging This Cycle Although the YTD appreciation in several commodities linked to supply and geopolitical fears, any supply-driven upside
is Jan-07 Jan-09 GSCI Spot Index Jan-11 Jan-13 DXY Spot Index Sources: Bloomberg, Morgan Stanley Commodity Research
(base metals, grains, natural gas) reinforce some of our concerns about commodities at this point in the cycle. However, the balance between supply and demand growth should improve as the cycle matures, particularly with some commodities trading closer to marginal cost. Grains and base metals are facing the
greatest supply growth in 2014. Production of corn, soybeans and wheat is expected to swell in the 13/14 - 14/15 marketing years, though we maintain that the lion’s share of supply growth has already been priced into the grains (particularly wheat and corn).
March 2014 15 95 90 85 80 75 70
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