Q4 Commodity Outlook: Tricky Road Ahead as Dollar Strengthens

Commodity markets will continue to be driven by worries about the potential impact of a slowing global economy. A solution to the sovereign debt crisis has still not been found and with governments running out of fresh ideas this has caused tremendous stress on the financial system. Cyclical commodities like energy and base metals have suffered as a consequence while safe haven flows and adverse weather have been the main reasons for gains across precious metals and agricultural commodities.

We believe that renewed dollar strength during September will continue into the last quarter and this could potentially have a dampening effect on the performance of commodities, ensuring a relative flat 2011 performance of the major commodity indices.

Energy: The dramatic spike in oil prices earlier this year has been a major reason for the surprise slowdown in economic activity witnessed during the past six months. The price of Brent crude, which has taken on the role as a global benchmark for a majority of global transactions, has so far averaged 111 dollars in 2011, well above the averages for the previous three years. Despite not reaching the record levels seen in 2008 it has nevertheless already spent more days above 100 dollars during 2011, thereby squeezing private consumption.

Increased demand drove prices higher in 2008 while this time supply disruptions and constraints have been the culprit for higher prices. Libyan oil production will be limited for months while supply disruptions from Nigeria, Syria and the North Sea have ensured higher prices compared with WTI crude which has stayed at depressed levels over the summer.

All of the growth in oil demand is now stemming from Emerging Market (EM) economies and in order to determine future price movements the economic well-being of these economies will be the decider. We expect the price of Brent crude to remain range bound for the remainder of the year between 100 and 120 with an end of year target of 105 dollars.

Precious metals: The rally in gold, which has now lasted for more than 10 years and has returned nearly 21 percent annually, is undoubtedly the world’s most powerful trend. Investors and central banks have all been competing for the yellow metal over the past two years as the global financial crisis has triggered an exodus out of other asset classes into “safer assets”, such as gold and silver.

During the third quarter record high prices led to increased volatility which dented some of the lustre for gold as it became increasingly difficult to trade. As a result we saw investors pulling out of long positions, both in ETFs and futures during August and September and we began to see 100 to 200+ dollar corrections. The super trend however remains firmly intact and only a move below 1,500 could spoil the party for investors holding close to 3,000 metric tonnes through various investment vehicles. We believe that gold may have another push to the upside reaching the magical 2,000 dollar level in early 2012 before a period of consolidation sets in.
Continued volatility could trigger additional margin increases on the major futures exchanges and force some investors to scale back positions even further. We see gold trading in a 1,650 to 1,950 range with an end of year target of 1,900. Silver has gone from being a driver to a follower of gold since the April price collapse. Given the weakened outlook for industrial metals we see silver potentially weakening further relative to gold with the value of one ounce of gold going from 50 to 55 ounces of silver.

Agriculture: Despite record planted acreage this crop year poor weather and reduced quality has led to a reduced U.S. production of corn and soybeans. This has caused a strong rally of the two over the summer in order to force demand rationing through higher prices. This rationing now seems to have begun having an impact on both feed demand and export. On this basis we believe that the prices of soybeans and corn have already peaked and could settle into 13 to 14 and 6 to 7 dollar ranges respectively for the remainder, also given our forecast for a stronger dollar which could dampen exports even further.