Commodities looking for equilibrium

After a rally, producers' hedging and profit taking could lead to correction, say observers

A sentiment-driven commodities rally is in a base-forming stage and “looking for some sort of equilibrium price”. While prices can go lower from here in the short term, due to producers hedging in futures or profit taking, revising of the previous lows seen a few months earlier might be a distant thing, analysts believe.

On Tuesday, international metals prices, along with share prices of these companies, saw a big fall; these stabilised on Wednesday. Brent crude oil is back to $40 a barrel and copper stabilised at $4,880 a tonne. Nickel fell sharply on Tuesday and rose on Wednesday by three per cemt. Gold, however, remained low.

Andrew Cole, senior base metal analyst at London-based Metal Bulletin, says: “Things aren't so bad to justify 12/13-year low levels. But, it is hard to make a case for rallies getting too strong, or continuing too far, as the fundamentals haven't actually improved. The building blocks aren't in place yet for a sustainable, V-shaped, recovery.” The commodities downswing built up a lot of momentum and now are “looking for some sort of equilibrium price”.

Tuesday’s fall was due to profit taking and hedging by mines and oil producers (selling future production in far-month futures to secure high prices). Some US shale oil producers are said to have sold the 2017 production in a March 2017 contract on the NYMEX, which is quoting an 18 per cent premium on current levels.

The next few weeks are important. On the coming Tuesday and Wednesday, the US Federal Reserve’s open market committee meets to review monetary policies. Next Wednesday, the petroleum exporters' cartel, Opec, meets to review supply and demand. After agreeing to freeze crude oil production at the current level and demand for storage from India and China, prices have rallied sharply. In three months, Brent crude has risen from $26 to $40 a barrel.

T Gnanasekar, Director at Commtrendz Research, a risk management company, said: “We might see correction in the form of profit taking or selling due to producers hedging. However, for the near term, he said, “Traders are staying away from creating short positions ahead of the Opec meeting and at every fall, there is buying support from countries for storage of oil.”

Production cuts across the board in almost all commodities, fear of a US rate increase and a Chinese slowdown amidst bearish sentiment has resulted in prices sliding. However, “a rebound like we've seen is reasonable because the market had got oversold”, said Cole.

Zinc, for example, has rallied 25 per cent off the lows and a 20 per cent up-move is often cited as criteria for a bull market. But, Andrew is not getting carried away. He said: “Prices can certainly go lower from here in the short term. In fact, they are more likely to correct lower than extend higher”, but he is not projecting a case for a bear trend, either. For example, nickel fell a little over eight per cent on the London Metal Exchange on Tuesday and recovered by three per cent on Wednesday. Copper's was a similar story.

Even for gold, Gnanasekar says, “The market has discounted the fact that the US is not raising rates now and the US presidential election has inbuilt uncertainties on the front of US policies.” He also says a huge US deficit is another risk built into the high gold price.

Gold was trading around $1,275 an ounce on Tuesday evening and is now at $1,250. Prices at the Mumbai spot market fell Rs 370 to close at Rs 29,200 per 10g. “I think the commodities downswing built up a lot of momentum late last year and we overshot on the downside at the deep lows in January, etc. We’ve now bounced back, looking for some sort of equilibrium price. Some metals have probably bounced too high, too soon. It makes more sense to think of this bounce as part of a broader base-building process,” Cole said.