Crude oil prices have risen around 100% from year-ago levels, and would need to surge up to close on $200 a barrel by the end of 2008, just to maintain the current pace of inflation. But as the Bank Credit Analyst puts it, the annual rate of change in both commodity energy and commodity food prices is now at an extreme, which is unsustainable.
Prices for leading food commodities - rice, wheat, soybeans and corn - have risen as much as 100% from 12-month lows, and when added to the huge price outperformance of energy futures, inflation fears remain contagious across the globe, and connected to everything from union strikes to investors pushing ever more cash into physical commodities, as a classic anti-inflation hedge.
While a number of individual commodities - such as uranium and lead - have corrected by more than 50% from highs, there is a growing belief that commodities are bullet proof, and should be bought on dips. There is also the increasing recognition of commodities as a discrete asset class.
Supply and demand deficits/surpluses for individual commodities vary widely. Beyond well-known operational and geopolitical risks, exogenous factors such as weather related events appear to be playing an increasingly significant role; the big current story is in the floods ravaging across the US's Midwest region. These have put huge impetus into corn and soybean futures prices, but the biggest gainer, where both US and global supply-demand is as tight as a piano wire, is seen in coal.
Benchmark Appalachian coal futures have risen by 151% from 12-month lows, vastly outperforming crude oil, natural gas and heating oil futures. Flood-related rail interruptions have principally hit coal transported east from the Powder River Basin of Wyoming and Montana, but the commodity pits are now also tuned into the Illinois Basin and Appalachia to see if floodwaters push towards the Gulf.
Either way, hot energy and food prices are set to keep inflation high up in global headlines. The mass media obsession with inflation is underpinned by central bankers who increasingly mention the word. Just as inflation may seem to be driving monetary policies, so too it may continue to drive activity in the commodity pits. Below the surface, however, the realities are quite different. US core consumer price inflation - which excludes energy and food - is set to continue drifting lower, driven by a neutral-to-weak domestic economy and the pitiless retrenchment in house prices.
Beyond that, US statistics show convincingly that pipeline energy and food pricing pressures are defused by the time the effects reach the retail level. Just as important, there is little if any risk of inflation leakage into wages, given rising unemployment in the US. Across in the Eurozone, headline inflation increased 3.7% year-on-year, from 3.3% in May, and core inflation edged up marginally.
The numbers underpinned the increasingly hawkish tones adopted by the European Central Bank, which also faces slowing economic activity among its constituent nations. Among emerging markets, there is yet to be any convincing evidence that inflation has broken out, although recent monetary moves, where found, have inevitably raised policy rates. In most developing markets, energy and food price inflation has been at least partially countered by rising productivity, and increasingly favourable terms of trade as globalization continues to develop more tentacles.
Looking forward on the commodity pricing front, the developed world's macro canvas is increasingly a contra-indicator for sustained underlying price pressures. The US and Japan are close to recession, and possibly there already; the UK is lurching rapidly south, and the Eurozone continues to plod towards a period of softer growth.
Commodity-inspired monetary restraint by central bankers is set to accelerate even softer global economic growth. Amid the markets, a convincing correction in crude oil futures is awaited before central bankers start relaxing a little. Until such time, investor demand for both selected commodities and the broader commodity complex is likely to remain positive, and bonds are likely to continue selling off.
As for substantial commodity sub-sector equity plays, little competes with potash over the past 12 months. In a research report out this week, RBC Capital Markets commented that the extremely strong crop price environment should translate into continued robust demand for fertilizers.
GLOBAL LISTED RESOURCES STOCKS
Composite weighted 12-month net price gains
* Investable market capitalisation
** IMC counted in other sub-sectors
Note: the 12-month price gains calculation assumes
1. A weighted amount of USD are invested in each of 699 stocks
2. At the stock's lowest price in the past 12 months, and
3. That each stock is still held at the current date.
Source: Analysis by Barry Sergeant
RBCCM also dealt with suggestions that there is a surplus of potash supply relative to demand. RBCCM believes this to be a misperception based on reported nameplate capacity figures. There is about 63-64m tons of global nameplate potash capacity at this time, says RBCCM. In comparison, there were only about 55m tons of potash deliveries in 2007.
A simple comparison could lead to the conclusion that there was a surplus of potash supply in 2007, states RBCCM; however, this comparison fails to recognize that it is difficult (if not impossible) for conventional potash producers to produce at nameplate capacity rates for extended periods of time.
RBCCM analysts believe that the world's supply of potash remains tight relative to global demand: We expect potash fertilizer market fundamentals to remain strong through 2014 given limited new capacity additions and growing demand. We believe phosphate fertilizer market conditions will remain strong until Saudi Arabia's Ma'aden diammonium phosphate facility commences operations in 2011/12. Leading potash miners also inevitably mine the other two key raw ingredients for fertiliser, phosphates and nitrogen.
RBCCM anticipates that cash flow per share for Saskatchewan-based PotashCorp, the world sector leader, is likely to increase to USD 14.39 this year, from USD 4.70 last year and just USD 2.95 in 2006. The forecast for 2009 is USD 24.51 a share. The forward 2009 cash flow-to-price number of 10 times is undemanding, by any measure, as is the forward earnings multiple of just 11 times. RBCCM has raised its PotashCorp target price on the NYSE to USD 340 a share, a little more than USD 100 higher than current prices.
* 12 month
Beyond the potash sub-sector, the top performers are also little changed, in iron ore, mining majors, platinum and coal. While the fundamentals for platinum remain uncontroversial, gold and silver bullion prices remain blown off after record levels early in March. Listed silver stocks appear to be increasingly vulnerable to cannibalization by silver ETFs. Gold bullion demand has been hit by price-related slackened demand from India, the world's biggest retail market. Listed gold stocks remain decisively in underperformance territory, with increasing numbers of names hitting 12-month lows.
Rising costs - real and imagined - have seen investors increasingly switch portfolio flows away from listed resources stocks and into commodity futures. This trend has been in place for some months, but has intensified over the past four weeks, after crude oil hit fresh records. There is also increasing investor anxiety over the rapidly rising costs of new projects, and of increasingly expensive stay-in-business maintenance costs.
For miners, rather than for investors in the final physical commodities, margin compression is also becoming an increasing reality on the revenues side of the income statement. Among base metals, copper and aluminium continue to cruise at high levels, but in the past few weeks, prices for nickel, zinc and lead been seen at half of 12-month highs.
On the broad resources equity front, valuations remain reasonable, with the exception of gold stocks, which continue to rank as expensive relative to other sub-sectors. Looking forward, investor attention is likely to remain timid for listed resources equities, and remain focused on broad based commodity indices, such as the S&P GSCI series, and ETFs focused on energy and food commodities.
Given the possibility that wider investment markets will begin to recognise inflation as less of a threat than it has been imagined to be, physical commodities can be expected to correct in due course. This may require a trigger, such as a decisive fall in crude oil prices, which, in turn, may be triggered by indicators showing that good old fashioned demand is growing at an increasingly slower rate, in line with the slackening of the global economy.
Selected commodity prices
NYMEX sweet, light crude
NYMEX sweet, light crude
Natural Gas (US)
Heating Oil (US)
Thai white rice
Rough Rice (US)