Commodities: A preview of 2008

In what the Chinese zodiac says 2007 was the year of the Golden Pig, we would say it certainly was: With Chinese equities up over 100% it has been a golden year for Chinese and emerging market investors.

Consistent with this is the positive performance of precious metals, making it a golden year. In India, due to Rupee appreciating 11% against dollar, gains in all commodities were limited.

2008 is the year of the rat. The Chinese Zodiac says the year of the rat will be volatile for commodities and equities. However 2008 is the year of the Earth Rat, which is prosperous for the earth and metal industries.

Only time will tell if the long term fundamentals of agriculture remain strong in 2008 and whether industrial metals can rally after being flat or down in 2007. Chinese and global demand will have a say in this.

Precious metals

Gold

The gold price increased by 35% over the past twelve months. At the beginning of 2007, the gold price was supported by a volatile oil price and weak USD, before the gold price weakened due to decreasing tensions between Iran and Syria.

The gold price remained weak during Q2 as the central banks increased gold sales and credit concerns deterred investment demand for gold as liquidity dried up.

However as the credit crunch intensified in July, gold's safe haven status returned. The unexpected interest rate cut by the US Fed, market volatility, and the decline of the US dollar pushed the gold price to a record high $845 in November.

Investment in the StreetTracks Gold Trust, an exchange-traded fund backed by bullion, surged 39 percent to a record 628 metric tons. The Fed lowered the benchmark lending rate 1 percentage point to 4.25 percent this year, sending the dollar in late November to $1.4967 against the euro, the lowest ever. Five of the past six bear markets in the dollar have rallied gold.

The view for gold is bullish for 2008 backed by the fundamentals, which keep the US dollar weak over a major part of 2008. Mine supply is not expected to significant improve in case of gold. The official sector sales also seem to be a weakening supply factor, given the real economic crisis faced by most gold-holding countries like the US, UK and Germany.

Then, there are chances of forex holdings diversification away from the dollar to bullion, which could also add to the demand and improve the bullish factor of gold. In 2008, minimum target is $1,000 based upon a continuation of the trends already in place, we could, however, see a spike to $1,200 if the credit crisis escalates and the central banks are forced to inject substantially more "liquidity" into the financial system than anticipated; or if tensions escalate to red alert status in the Middle East.

While speculative long positions in gold are high and, there is potential for short-term price corrections, there is a strong medium-term up trend for gold.

Silver

The silver price rose 16% over the past twelve months. The silver price generally tends to be positively correlated with the gold price, but because silver has many industrial applications (such as film processing, electrical appliances, batteries, superconductors), its price is also affected by the economic outlook.

When the turmoil hit financial markets this summer, the silver price decoupled from the gold price as investors sensed the potential impact of an economic downturn on silver demand, with the Gold-Silver ratio increasing from 52 to 56 during the third week of August.

Silver's production is a by-product of mining other metals, therefore silver prices remain sensitive to supply of related industrial metals such as gold, copper, lead and zinc.

Silver mine supply is expected to improve in 2008, thereby causing an additional surplus to the tune of about 1000 MT, which would keep the prices under pressure.

Energy

Crude oil

Oil increased by approximately 57% over the past twelve months. Since the oil price dropped from its peak of $79 in 2006, the oil price remained between $50 and $70 during the first 2 quarters.

In mid July 2007, the oil forward curve turned from contango to backwardation, reflecting among other things an increase in the supply deficit when the EIA announced lower than expected oil inventories. In the meantime, Brent oil started trading at a premium to WTI as a result of depletion of North Sea oil field.

Oil prices continued to strengthen in September and October due to a mixture of factors including a lower than expected production increase announced by OPEC, low US stocks at Cushing, supply disruptions in Mexico, and a reduction in output by non-OPEC oil producers. Growing tensions in Turkey, followed by the announcement of falling US stocks, sent the oil price even higher to close to $100.

Although high oil prices and weaker economic growth may soften demand, several factors remain supportive of oil prices, such as strong demand growth from China and other emerging economies, declining OECD commercial inventories, and low OPEC surplus production capacity. Meanwhile, slower economic growth and financial market turmoil pose a downside risk to oil prices.

The International Energy Agency has revised up its global oil demand forecast for 2008 by 115,000 barrels a day to 87.8 million barrels a day global supply of 87.385 million barrels a day. The EIA has also forecast global oil markets will likely remain tight through 2008. World oil demand will grow much faster than oil supply outside of the OPEC. Meanwhile, world oil consumption in 2008 is projected to rise by 1.4 million barrels to 87.16 million barrels a day.

Natural gas

Natural Gas rose by 17%. Natural Gas started the year with high inventories after a warmer than usual winter in 2006. The natural gas price then rebounded as the weather returned to normal, consuming some of the natural gas surplus. The price remained stable until June, when the supply deficit reduced considerably due to the mild weather in summer.

The price increased in August 2007 due to a hurricane in the Gulf of Mexico, which was likely to lead to the shutdown of the gas production, but the price then fell as the hurricane moved away. With lower LNG imports, the price recovered from the fall in August.

With cold weather approaching and higher oil prices, demand for natural gas was tight in November despite large inventories.

According to EIA Estimates Natural Gas consumption in 2008 will rise by 1.07% to 63.09 billion cubic feet per day. Meanwhile Natural Gas storage is decreasing from last two years and expected to decrease further from monthly average 2603 billion cubic feet in 2007 to 2828 billion cubic feet in 2008.

Base metals

The future of base metals would be in part decided by the recovery in the US economy, which witnessed the sub-prime debacle in 2007, and the direction will be determined by combined efforts of the developed and developing economies.

In the first quarter of 2008, continued global weakness will reduce consumption of base metals. Prices may recovery by the second quarter of 2008 once the macroeconomic effect of the cut in rates sinks in. Moreover, the US Housing sector is expected to recover after the end of the US winter season. The recovery of the US housing sector is expected to increase the demand of base metals.

Copper

After reaching an all-time high in May 2006 of $8,800, copper cash prices on the LME plummeted on growing inventories and Chinese destocking. Copper prices remained depressed during the 1Q07 as weak US employment and housing market data hinted to an economic slowdown.

Copper prices rebounded in February after a surge in Chinese imports and a gradual decline in LME inventories, returning the market back into deficit.

US sub prime mortgage lending woes, weak housing market suggest bleak copper demand from the world's second biggest consuming nation. Copper prices may remain volatile due to low inventory levels and uncertainty about the US and global economic outlook, while demand for power generation in China, accounting for 23% of the world copper demand and Infrastructure development in developing countries should support prices.

Nickel

Nickel prices reached their all-time high in the second quarter of 2007, supported by historically low LME inventory levels and strong global demand for stainless steel. The fabrication of stainless steel accounts for about 60% of the demand for nickel. Since mid 2007 several factors have led to a sharp correction in nickel prices, including stainless steel de-stocking and the announcement by nickel producers of an increase in future output.

Lot of developments in nickel market shaped the southward price movements some of them being slowdown in steel production, steel producers shifting production to less nickel contained steel grade, substitution by to Nickel Pig Iron containing less nickel.

In 2008,Nickel Prices will be affected by low LME inventory levels and continued delays to major new growth projects. A large portion of production growth is expected to come from brownfield expansions and low-grade, high-cost Chinese nickel pig iron. Steel prices are again getting in momentum as demand continues to rise which is likely to see more of steel production coming next year and therefore recovery in primary nickel demand.

Zinc

Zinc fell by 43% over the past twelve months. Zinc cash prices on the LME reached their all-time high of $4,658 in November 2006 due to record low inventories, however a rebound in stocks triggered a sharp correction during the first quarter of 2007. The start of zinc trading on the Shanghai Futures Exchange resulted in a sharp reduction in Chinese exports during March 2007 and an increase in imports, helping to foster a rebound in zinc prices.

Moreover, restart of new and existing mines in 2007 with huge capacities increased the supply in Zinc Market in 2007 by around 1 million tonnes. While development in Asian countries, which led to high demand was offset by Credit and Housing Crisis in US.

Growth in Vehicle production and Infrastructure development in China and India is expected to remain strong, resulting in increased demand for galvanized steel sheet used in the bodies of cars and trucks in 2008. In India, however, the infrastructure development will continue, especially with the Commonwealth Games to be held in 2010.

In the US, rising demand for galvanized steel in non-housing construction is expected to offset lower demand from residential construction associated with the downturn in the housing market. Zinc prices will be volatile in 2008 as with forecasted surplus of 0.37 million tonnes. LME Zinc Support is around $1900 and Resistance around $3200.

Lead

In June 2006, lead stockpiles turned the corner and commenced a draw that saw 82% of the inventory disappear. And this draw ignited a powerful upleg that saw lead rocket 335% higher in this same 16-month span. This brought LME lead stockpiles down to only 20k metric tons in October 2007, the equivalent of only about one day of daily global consumption.

Lead was best performing commodity till mid October 2007 by rising 135% and then prices plunged 40% in two months on rising inventory. Magellan Lead mine, which accounts for 3 percent of the world's mined lead, was shut by Ivernia in April after health officials halted lead exports from the Port of Esperance following a large number of bird deaths from lead poisoning. Lead prices also got the boost throughout the year on this mine news, but in November, it was announced that Ivernia is hoping to resume shipments from the mine in 2008 via the Port of Fremantle, which made prices to plunge.

Lead can hold its ground between $2,000-2,150 in 2008 with an upside potential in the second half upto $3,200. Prices may recovery by the second quarter of 2008 once the macroeconomic effect of the cut in rates sinks in. Lead prices will be volatile in 2008 as with forecasted surplus of 0.15 million tonnes.

Commodity	Forecasted Average Price
Gold	920 $/ ounce
Silver	16 $/ ounce
Copper	6350 $/ tonne
Nickel	28000 $/ tonne
Lead	2900 $/ tonne
Zinc	2800 $/ tonne
Crude Oil	95 $/ barrel
Natural Gas	8.5 $/ mmbtu

Renisha Chainani is a Commodity Research Analyst with Anagram Comtrade Ltd