Perils of commodity price forecasting: The case of nickel

Ahead of the New Year, commodity specialists and merchant bankers will be routinely engaged in crystal gazing about price behaviour of a whole range of industrial and agricultural commodities. Funds and operators will buy forward items that find favour with experts. Commodity forecasting is an all-time risky pursuit. The perils of price predictions by experts are underpinned by investors incurring losses as often as they would earn profits by following the script. If a tally is taken of performances of core base metals traded on London Metal Exchange during 2014, then forecasters have very little to take credit for their work. Reuters says, in a report, "Only copper and, to a lesser extent, zinc have performed anywhere close to script but even that statement comes with plenty of caveats." Specialists can hardly be blamed for their predictions going haywire due to unforeseen developments.

A few examples might be cited to underline the point. First, who could have thought in June that Organization of the Petroleum Exporting Countries (OPEC), led by Saudi Arabia, would avoid market intervention by way of production quota cuts for members and let crude oil prices fall nearly 50 per cent. Second, proving all forecasters wrong, nickel, used for rust-proofing of alloy and stainless steel, went through a roller coaster ride through 2014, due to some not unexpected developments concerning Indonesia and a few surprising occurrences on the nickel ore supply side. Third, the world is reconciled to the slowing growth of China, which rules the commodity roost. But, who could have thought the largescale illegal practice of tendering same inventories of imported industrial raw materials and finished products as bank collateral would get busted when it did?

The sharp fall in prices of metallurgical coal, a blessing for India, being largely import-reliant for this steelmaking ingredient, and iron ore, of which Chinese imports account for nearly two-thirds of seaborne trade, are partly the result of Beijing's attempt to rein in parallel banking. Between January and mid-May 2014, nickel made a spectacular price gain of nearly 50 per cent, principally on the back of Indonesia which, in normal times, had nearly a 30 per cent share of the world supply of nickel ore, putting a ban on exports. Djakarta's objective is to force importers to build smelters and refineries in Indonesia, so that the country benefits from value addition. The export ban on nickel ore and bauxite was also to have covered copper ore and some other minerals. But in last-minute changes, Djakarta allowed shipments of copper concentrate, which many suspect was to placate US mining giants Freeport McMoran and Newmont Mining. Between the two, they extract well over 95 per cent of Indonesian copper ore.

The behaviour of commodities contrary to forecasts cannot but compromise the credibility of experts. This is also one compelling reason for investment funds and banks to start moving money from commodities to the equity market. In any case, commodities have ceased yielding sustained return for investors. It will, however, be doing injustice to paint forecasters in a bad light for their not anticipating that the nickel rally would fizzle by May-end. How would anyone have known that the lid on the scandal surrounding stockpiling of nickel by dodgy traders at China's Qingdao port would be blown off at that point? The result was stored nickel at Chinese ports had to be moved to LME registered warehouses elsewhere in Asia. As London Metal Exchange inventory rose to new highs, price reaction became inevitable.

What also pulled the market down was stepped-up supply of nickel ore from the Philippines. At the beginning of 2014, a strong price rally was forecast, based on the Indonesian ban, which was held through regime change. Court rulings on a miners' relief plea did not provide for Filipino ore supplies coming to the rescue of Chinese nickel pig iron (NPI) producers. Compared to China, Filipino ore is of inferior quality. But by drawing from their inventory of Indonesian ore, Chinese NPI makers are blending it with Filipino mineral to overcome quality issues. With a share of 50 per cent of world production of stainless steel and heavily dependent on nickel ore imports, China is also finding comfort in gradual emergence of Vietnam and Malaysia as suppliers. Growing supply easiness has not, however, stopped financial services group Macquarie from forecasting that nickel could see "a 50 per cent upside next year. Prices will rise to an average of $23,750 a tonne."