Commodities should take off later this year

Kathleen Brooks
MARKETS tend to react quickly to bad news. Last month, after fears that the Greek debt crisis could spread across Europe and dent the outlook for global growth, the markets traded lower as investors sold risky assets.

Commodities – sensitive to the global growth outlook – were hit hard. For example, the oil price fell more than $10 per barrel last month. This is a good opportunity to pick up commodities on the cheap. Analysts at Societe Generale believe that the factors are in place for an upswing in prices.

Firstly, the economic environment actually looks supportive for commodities. For example, at the end of May the Organisation for Economic Cooperation and Development (OECD) raised its outlook for GDP across OECD countries to 2.7 per cent this year and 2.8 per cent in 2011, compared with its previous forecasts of 1.9 per cent and 2.5 per cent respectively. In the same way, economists at Royal Bank of Scotland (RBS) have also increased their global growth outlook for this year from 4.2 per cent to 4.7 per cent.

Last month’s sell-off was partly fuelled by fears about a slowdown in China, which,
along with other emerging markets, has led growth in demand for commodities in recent years. Concerns that measures taken by the Chinese authorities to slow down the property boom would hurt demand for raw materials also seem overdone. China’s economic data looks as strong as ever: exports in May expanded at a whopping 48 per cent rate compared to a year previously, and analysts at RBS expect GDP to grow at a solid 11 per cent this year.

Infrastructure spending in emerging markets should continue for the foreseeable future, which supports a bullish outlook for the oil price as well as the price of steel, platinum and silver and other metals that have an industrial use.

Inflows to commodity indices have been strong over the last nine months, as you can see on the chart, and although they may have dipped in the past month or so, Societe Generale expects inflows to pick up again later this year, which supports price appreciation later in 2010.

Supply and demand fundamentals should help to boost the oil price. Although fears remain that austerity measures could thwart growth in Europe, oil did not fall below the $70-per-barrel mark last month. Analysts believe this was due to fears that the Organisation of the Petroleum Exporting Countries (Opec) will cut output if prices fall below that critical level. If oil supply is cut without a similar adjustment in demand, prices for oil should rise. SG also argue that seasonal demand for oil, should boost the oil price in August, as the Northern hemisphere stocks up for the winter months.

So how should contract for difference traders get exposure to commodities? Societe Generale recommends a long position in the December 2010 contract for WTI crude and the silver and palladium spot contracts.

Naysayers for future growth may have helped push commodities down last month.
However, their messages of doom went too far, which has left plenty of opportunity for investors.