Date Published: June 30, 2020
It's been a wild few months for commodity markets. Despite some recent setbacks, commodity prices have broadly bounced back in tandem with other risk assets from their April lows as the global economic recovery started to gain traction. Movements since May have been dictated by a widespread lifting of government restrictions, and consequently, hopes of a sustained pickup in commodity demand. Supply-side developments in the form of coordinated curtailments and pandemic-related involuntary shutdowns have also been key.
Notwithstanding the recent upward momentum, commodity prices will continue to face an uphill battle back to pre-pandemic price levels. The past few months have highlighted that the commodity complex cannot be painted with the same brush. Copper and oil, considered bellwethers of global growth, have led the march back after leading the COVID-19 sell-off. Nonetheless, oil still has significant ground to make up relative to pre-COVID-19 peaks (Chart 1). Meanwhile, agriculture and forestry markets are facing their own idiosyncrasies. For instance, demand for crops has been less impacted, but markets continue to swim in plentiful supply that pre-dates the COVID-19 shock. Significant price declines in lumber were reversed, as widespread mill curtailments helped tighten the market.
A challenge facing further commodity price gains through the summer is that much of the good news surrounding the global recovery appears to have been largely priced in. Indeed, there is a good case to be made that prices in a number of areas may have moved too far, too fast, raising the risk of a near-term pullback.
At the risk of sounding like a broken record, the outlook for commodity prices remains subject to heightened uncertainty. It is predicated on a continued recovery in global economic activity. Additionally, a second COVID-19 wave is assumed to be met with less stringent shutdowns than those in April. In certain hard-hit areas like oil markets, the outlook also hinges on continued supply-side support. As such, risks to the outlook remain tilted to the downside.
COVID-19 has wreaked havoc in oil markets, sending WTI prices spiraling below US$20 during the second half of April, and pushing the benchmark into negative territory for the first time in history (Chart 2). The chaos seen in oil markets during the March-April time period has since subsided, with signs of a rebalancing supporting a bounce-back in prices to around the US$40 mark.
Front and center in supporting this rebalancing were supply-side developments. OPEC+'s deal to cut production by a combined 9.7 million bpd (relative to October 2018 levels) was extended by an extra month to the end of July. This extension came on top of an additional voluntary 1.18 million bpd cut from Saudi Arabia, Kuwait, and the UAE in the month of June (those cuts are set to expire at the end of this month). At the same time, market-driven declines outside of OPEC+ were larger than anticipated. Indeed, production has fallen by at least 2.6 million bpd from its peak in the U.S. (Chart 3), although it has since started to rebound. Canada has also significantly cut production, and lesser declines were also reported elsewhere.
Meanwhile, demand continues to gradually recover as restrictions on manufacturing and consumer activity are lifted. In turn, mobility indicators have gradually improved in most countries. In the U.S., the latest EIA data suggests that gasoline demand is now 9% below year-ago levels (compared to a low of around -45% in April). Total global flight activity has also bottomed out, and is now around 30% below pre-COVID levels, although commercial flights are still down more than 50%.2 China, a key driver for oil demand growth since the financial crisis, has seen its oil imports rise above pre-COVID levels in May.
Notwithstanding these positive developments, recent price strength may have been overdone, and the risk of a modest pullback is still present in the near term. On the demand side, a return to the 100 million bpd mark is still a long way – especially with the expectation that jet fuel will take years to recover. Although modestly rebounding, refineries in North America continue to operate well below capacity, and work-from-home arrangements may prolong a further acceleration in gasoline demand. Demand for industrial and freight uses, less impacted by COVID-19, is not expected to accelerate amid still-subdued manufacturing sentiment and global trade. Importantly, peak supply-side support is expected to lessen in the months ahead. Starting in July, the voluntary 1.2 million bpd cut from some OPEC countries will end. By August, OPEC+'s curtailments will drop from 9.7 million bpd to 7.7 million bpd1. With prices now above operating break-even levels for many producers in the U.S. and Canada, some are also expected to start resuming previously shut-in production (see Chart 4).
The biggest drag, however, is the sizeable inventory overhang. The unprecedented imbalances seen in the March-April period are expected to have left oil markets with an inventory overhang that will need to be worked down through 2021.
From Q4 onwards, we expect prices to oscillate in the US$40-50, with the higher end of this range likely only approached in the latter part of next year as inventories get worked down somewhat nearer to pre-COVID levels. Beyond this, the sizeable drop in U.S. oil and gas investment (and consequently oil rigs drilling) is expected to translate into lower production in the longer term, potentially bringing upside risk to prices if global demand manages to return to the 100 million bpd mark.
In Canada, the WCS spread has widened to a still-decent US$10 after dropping to record lows in the late April-early May time period. WCS prices are now closer to the US$30 mark, after sitting in the single-digit territory for the majority of April. Reduced Canadian production in response to lower oil prices has resulted in lower crude-by-rail shipments and put downward pressure on pipeline and storage capacity in the landlocked Western Canada Sedimentary Basin (WCSB). Production is expected to rebound, but only gradually as some producers wait to assess uncertainty around the virus and the expected demand path. Not all producers are subject to WCS pricing, but for those who are, the pricing environment is now not too far from January (pre-COVID-19) levels.
2020 got off to a rocky start for natural gas markets, which were already struggling with price softness that pre-dated COVID-19. U.S. Production had hit record levels in late 2019, pushing inventory levels above the 5-year average (Chart 5). Following COVID-19, demand for natural gas has not been as hard-hit as oil, but a combination of elevated domestic storage and a global supply glut has weighed on prices. A drop in global demand, elevated supply elsewhere (namely Europe), and soft global LNG markets are weighing on U.S. natural gas prices and exports3. The drop in the latter would also exacerbate already-high storage levels.
Against this backdrop, U.S. natural gas production and capital expenditures have followed oil production lower. The significant drop in gas rigs will translate to a continued decline in future dry gas production, with the EIA anticipating a 11.1% decline from the first quarter of this year to that of 2020. This points to some price increases as the withdrawal season approaches next fall and into 2021.
Fortunes for base metals are being dictated by its largest consumer, China. With China leading the post-COVID rebound since late April, base metal prices have benefitted. However, like oil, the price recovery is built on shaky grounds. China's recently-announced stimulus measures, are supportive. However, they are conservative in comparison to the post-2008 package as they come against heightened debt concerns. Outside of China, global manufacturing activity, while rebounding, still remains in contractionary territory in many countries.
Once more, supply-side forces will drive a wedge between performances. Copper is already benefitting from declining inventories (Chart 6), especially those tracked by the Shanghai Futures Exchange. Pandemic-related disruptions to mine activity and production in Latin America and elsewhere are also lifting prices. This should prevent prices from slipping, but sustained further upside is highly dependent on China's demand growth picture. In the medium term, Nickel supply growth will also remain constrained by Indonesia's ban on nickel exports. At the other end of the spectrum, Aluminum is expected to underperform given rising supply and inventories. With reports of a potential re-imposition of U.S. aluminum tariffs on Canadian imports, the price impacts (if implemented) would likely be centered to consumers in North America. An oversupplied global and Chinese market will continue to dictate the overall global price picture.
Precious metals have bucked the trend seen elsewhere during the pandemic. The yellow metal has been benefitting from the combination of heightened uncertainty, low interest rates, and a ramp up of central bank purchases since last year. The pandemic came along and amplified these tailwinds. Investor demand has continued to surge in relatively unabated fashion, and gold ETF holdings continue to hit record-highs (Chart 7). Although not our base case, the post-pandemic intersection of unprecedented fiscal and monetary stimulus has also raised concerns about the potential for an spike in future inflation, which would be supportive for gold prices.
However, there is reason to believe that the rally will run out of steam once these tailwinds abate in 2021. Bond yields have arguably bottomed out, and peak uncertainty will likely diminish once the U.S. presidential elections are over in the fall and more information around a potential COVID-19 second wave comes to light
Agricultural markets were not left unscathed by COVID-19 – but the hit to most grain prices was less than that seen elsewhere as demand for food remained stable. Looking ahead, grain prices are not expected to turn the corner anytime soon given the oversupply backdrop that pre-dated COVID-19. USDA expects production and global ending stocks (Chart 8) for wheat to rise again this year, prompting our expectation for near-flat price performance. Balances for oilseed markets are expected to have improved, from 2018-19 but continued increases in supply and exports outside North America will act as a headwind. Likeweise, Chinese import restrictions will continue to cap any price acceleration for canola.
Livestock markets, on the other hand, were hard-hit. Hog prices were initially impacted following China's shutdown in February. Additionally, North American supply remains elevated, especially for hogs. Cattle prices have also tumbled in response to pandemic-driven closures of meat-processing plants. Going forward, prices are expected to trend modestly upwards as inventories ease and demand for pork solidifies amid African Swine Fever shortages in
China and elsewhere. Cattle prices are also expected to gradually recover, but will face potential downside risks from a weak global economic and income backdrop.
A perfect storm of shipping disruptions and tanking construction activity sent lumber prices tumbling in March. Prices have since staged a strong and persistent rebound as mill closures across North America contributed to improved demand-supply balances. Looking ahead, lumber prices will benefit from an expected strong recovery in U.S. housing markets. Mortgage applications for U.S. have continued to rise, and home sales have bounced back strongly. This, combined with the supportive borrowing environment is expected to translate to robust housing starts going forward. With this in mind, prices have already surged in the past few weeks. We don't expect further price growth going forward, as these tailwinds come against a potential easing of mill curtailments.
|Table 1: Commodity Price Forecast Summary|
|Spot Price||Q4||Annual Average|
|Non-Precious Metals & Minerals**|
|Agriculture & Forestry*|
|Source: *Forecasts by TD Economics as of June 2020 ** forecasts by TD Securities and TD Economics as of June 2020|
MEASURES & QUOTED PRICES
($ is US$ unless stated otherwise; C$ prices converted to US$ using daily C$/US$ exchange rate).
Lumber: Random Lengths' Framing Lumber Composite ($/1000 Bd Ft)
Oil: Domestic Spot Market Price: West Texas Intermediate, Cushing ($/Barrel); Natural Gas: Henry Hub, LA ($/mmbtu)
Silver: Cash price: Silver, Troy Oz, Handy & Harman Base Price ($/Troy oz); Gold: Cash Price: London Gold Bullion, PM Fix ($/Troy oz)
NON-PRECIOUS METALS & MINERALS
Aluminum: LME Aluminum, 99.7% Purity: Closing Cash Price (Cents/lb); Copper: LME Copper, Grade A: Closing Cash Price (Cents/lb); Nickel: LME Nickel: Closing Cash Price ($/lb); Zinc: LME Zinc: Closing Cash Price (Cents/lb); Uranium: Ux U308 ($/lb)
Wheat: Spring,14%Protein: Minneapolis ($/bu); Canola: Canada: Cash Pr: Canola: Instore Vancouver: Grade 1 Canada NCC (C$/mt); Cattle: Live Cattle Futures Price: 1st Expiring Contract Open (Cents/lb); Hogs: Lean Hogs Futures Price: 1st Expiring Contract Open (Cents/lb)
Sources: WSJ, FT, Ux Weekly, Random Lenghts, CME, FRBNY / Haver Analytics, Bloomberg.
|Table 2: Commodity Price Forecast Summary % Change|
|Non-Precious Metals & Minerals**|
|Agriculture & Forestry*|
|Source: * Forecasts by TD Economics as of June 2020 ** forecasts by TD Securities and TD Economics as of June 2020|
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