The recovery debate

Fundamentals of the commodities market have not changed

Many are beginning to question whether the slump in global commodity prices is coming to an end. For almost two years, commodity prices have slumped, driven by slowing demand and over-supply. In the process, major commodity exporting countries and sectors have been hit. Countries such as Brazil have seen growth slow significantly. India is, by and large, a commodities importer, and as such has benefited - the moderation in inflation owes much to lower commodity prices. But even within India, certain sectors - such as metals, for example - have suffered, and added to the stress in the financial system. But, over the course of 2016 so far, some have detected signs of a commodity revival. For the first time in years, the Dow Jones Commodity Index has beaten the S&P500 index of stocks. Iron ore prices have gained over 40 per cent since January - including a spike in the past week after news came in that China might revive infrastructure spending as the high season for construction begins in that country. And last Friday, the International Energy Agency suggested that crude oil prices might have "bottomed out", after a prolonged slump since June 2014 that saw prices crash by 65 per cent. This followed the price of barrel of Brent crude oil breaking the $40-barrier for the first time in months.

However, the voices of caution have been equally strong - and perhaps stronger. The fundamentals of the global economy have hardly changed enough to warrant a surfeit of optimism about the future direction of commodity prices. While it is true that, at China's annual National People's Congress, it was announced that a record high budget deficit and even looser money supply would be permitted in the coming year in order to meet growth targets, it may be too much to assume that this will correspond to a revival of demand sufficient to steadily lift commodity prices. China's commitment to its "rebalancing" away from construction- and investment-driven growth remains, and confusion as to policy aims from its authorities has become sadly common over the past year. Few signs of actual revival are being reported from the ground; its exports continue to slump. And the National People's Congress also re-committed the Chinese government to cutting over-capacity, particularly in steel.

Meanwhile, the path of oil prices remains a dangerous puzzle. The proposed freeze of crude oil production at the levels seen during January this year - an agreement between the leaders of the Organization of Petroleum Exporting Countries, or OPEC, and a major non-OPEC producer, Russia - still awaits Iran's final position. Iran, excluded from the oil market for years due to international sanctions over its nuclear programme, will not want any such agreement to come in the way of its ramping up production to at least its pre-sanctions share of the world petroleum trade. Meanwhile, shale gas and oil production in the United States serve as an effective cap on the price of crude oil, which could hit a ceiling somewhere between $55 and $60 a barrel - the price at which additional shale capacity becomes profitable and competitive, and mothballed facilities come online. Overall, while the commodity bounce may continue for some time in several commodities - some of which may have overshot their true market value during the years-long slump - few rational observers hold expectations of a return to the commodity boom years.