Commodity rally losing steam post QE3

Growth concerns on China and anticipation of no early end to turmoil in Europe depress price expectations, say analysts

The rally in commodity prices seems to be losing steam after the announcement of a third round of quantitative easing (QE3) by the US Federal Reserve in the middle of this month. Prices were already up before the announcements and once the news was out, follow-up buying from real sectors didn’t happen due to growth concerns.

While smaller metals are still up, prices of copper, aluminium, crude oil and gold have plateaued or fallen after the announcement. Analysts say the growth issue is again at the fore, not leaving any strength for the sort of rally seen following earlier liquidity pumping by central banks in the past. In 2009 and 2010, when the first two rounds of QE were announced, commodities rallied sharply before the announcements. Market players were hoping liquidity easing will find its place in financial markets, as players will buy commodities before real demand picks up.

Compared to QE2, this time commodities have not fallen sharply. In the current quarter, prior to the announcement of QE3, metals, precious metals and crude oil went up 10-26 per cent on hope of QE3. Prior to QE2, too, commodities markets were significantly up but after this, profit booking in commodities was sharper and most were down by three to five per cent, with smaller metals falling 10 per cent in the first fortnight after the announcement.

"The markets seem to have shrugged off the measures being introduced under QE3, as concern over the outlook in China and the anticipated continuing market turmoil in Europe have a significant bearing on prices," said Raju Daswani, managing director, Metal Bulletin Ltd.

Following a weak June quarter from the point of view of their prices, commodities rallied strongly from July on expectations of an announcement of a third round of liquidity easing in the US. Prices were falling prior to that, due to concerns on Europe. This rally prior to the QE3 announcement (July to mid-September) had made the quarter one of the strongest periods for commodity indices since early 2009. A range of factors contributed to this turnaround, including bad weather that has boosted many agricultural commodity markets, rising geopolitical tensions supporting oil prices, and a further quantitative easing and better risk appetite, both particularly important factors in the recent recovery in base and precious metals prices.

However, “At this point, growth is the big problem for commodities, not liquidity,” said Kevin Norrish, analyst at Barclays Commodities. “When QE2 was announced in November 2010, the global economy was halfway through a quarter in which GDP growth averaged four per cent, followed by one of 3.7 per cent. Crucially for commodities, China was expanding at an annualised rate of 9.5 per cent. Even if QE3 proves successful, growth over the remainder of this year will likely be much lower. Global leading indicators have deteriorated markedly in the past month and are pointing to the risk of a big slowdown in the manufacturing sector, while economists are cutting their forecasts for Chinese and European growth.”

TAKING A HIT Price change in various commodities since QE2 and QE3
In $/tonne	QE2	% Change			QE3	Sep 27, 12	% change
	Nov 03, 10	Nov 17, 10	after QE2	Jun 30, 12	Sep 13, 12		Before QE3	After QE3
LME Lead	2,490.00	2,222.00	-10.76	1,796.00	2,112.50	2,273.00	17.62	7.60
LME Nickel	23,625.00	21,475.00	-9.10	16,475.00	16,680.00	17,930.00	1.24	7.49
LME Zinc	2,427.00	2,085.00	-14.09	1,843.00	1,984.50	2,068.00	7.68	4.21
LME Tin	25,850.00	24,350.00	-5.80	18,775.00	20,325.00	20,995.00	8.26	3.3
LME Copper	8,400.50	8,145.00	-3.04	7,604.50	8,055.50	8,130.50	5.93	0.93
Gold Spot *	1,348.54	1,336.05	-0.93	1,597.45	1,767.12	1,758.45	10.62	-0.49
Silver Spot *	24.86	25.65	3.19	27.50	34.66	34.13	26.07	-1.55
LME Aluminium	2,401.50	2,225.00	-7.35	1,834.50	2,082.00	2,049.00	13.49	-1.59
Brent Crude #	86.11	82.60	-4.08	97.00	116.41	111.18	20.01	-4.49
*$/oz; #$/bbl                                                                                   Source: Bloomberg; Compiled by Bs Research Bureau

In fact, the August trade data from China, a major commodity consuming country, showed moderation, with crude oil imports falling to the lowest in two years and copper import growth contraction. Lead imports rose 50 per cent and so did its price on the London Metal Exchange. Lead was up four per cent after QE3 and by 17 per cent prior to QE3.

According to Norrish: “Weakness in China’s commodity imports will become more pervasive, especially with high inventories overhanging sectors such as copper and steel.”

Even if commodities find some support from liquidity in the fourth quarter, prices could correct afterwards, as only real growth-related demand can support high prices and in their absence, prices could actually fall in early 2013.

Citi’s Mark Liinamaa says, “Our commodity team thinks the recent metal price rally could run through the year-end due to excess liquidity. In China, physical metal demand could improve in the fourth quarter, with a swing to re-stocking in the broader economy after an extended period of working off finished goods inventory. However, global growth is expected at 3.1 per cent and with healthy metal inventories and a backdrop of uncertain Chinese demand, prices will retreat in early 2013 from recent highs.”