Tumbling Base Metal Prices Are Out of Sync FORECASTER

COMMODITY TRENDS

François Dupuis, Vice-President and Chief Economist • Carine Bergevin-Chammah, Economist • Mathieu D’Anjou, Senior Economist

Desjardins, Economic Studies: 514-281-2336 or 1 866-866-7000, ext. 5552336 • [email protected] • desjardins.com/economics

NOTE TO READERS: The letters k, M and B are used in texts and tables to refer to thousands, millions and billions respectively.IMPORTANT: This document is based on public information and may under no circumstances be used or construed as a commitment by Desjardins Group. While the information provided has been determined on the basis of data obtained from sources that are deemed to be reliable, Desjardins Group in no way warrants that the information is accurate or complete. The document is provided solely for information purposes and does not constitute an offer or solicitation for purchase or sale. Desjardins Group takes no responsibility for the consequences of any decision whatsoever made on the basis of the data contained herein and does not hereby undertake to provide any advice, notably in the area of investment services. The data on prices or margins are provided for information purposes and may be modified at any time, based on such factors as market conditions. The past performances and projections expressed herein are no guarantee of future performance. The opinions and forecasts contained herein are, unless otherwise indicated, those of the document’s authors and do not represent the opinions of any other person or the official position of Desjardins Group. Copyright © 2018, Desjardins Group. All rights reserved.

CONTENTSEditorial ............................................................. 1Energy ............................................................... 2

Base Metals ....................................................... 4Precious Metals ................................................. 6

Other Commodities ........................................... 7Tables ................................................................ 8

Commodity prices have generally been down recently (graph 1). Oil experienced more volatility and the price for a barrel of WTI (West Texas Intermediate) briefly rose above US$70, but settled just below this level. The limited oil supply, which is exerting upside pressure on prices, was offset by fears of a global economic slowdown, which could soften demand. The situation needs to be watched closely as several uncertain factors could tip the scale in either direction.

The greenback’s appreciation has had a negative impact on commodity prices, especially for industrial metals and gold (graph 2). Trade conflicts, which are threatening the health of the global economy, have fuelled concerns and are weighing on industrial metal prices. As mentioned in a recently published Economic News, a true deterioration in the economic environment would cause prices for industrial metals and gold to move in opposite directions. Their synchronized downward drift indicates that uncertainty and a strong dollar were the main cause behind the drop in metal prices. As economic growth remains strong, industrial metal prices should recover, especially if the uncertainty tapers off.

François Dupuis, Vice-President and Chief Economist

Carine Bergevin-Chammah, Economist

Tumbling Base Metal Prices Are Out of Sync with Fundamentals

ECONOMIC STUDIES | AUGUST 9, 2018

GRAPH 1 Only energy is significantly up compared to early 2018, driven by oil

Sources: Datastream and Desjardins, Economic Studies

Bloomberg Commodity Index and its components

Jan. 2018 = 100

70

80

90

100

110

120

130

JAN. APR. JUL. OCT. JAN. APR. JUL.

Index Energy Industrial metals Precious metals Cereals

2017 2018

GRAPH 2 The sharp rise of the U.S. dollar is weighing on copper and gold prices


Jan. 2015 = 100

85

90

95

100

105

60

70

80

90

100

110

120

2015 2016 2017 2018

Copper (left) Gold (left) Trade-weighted U.S. dollar index (right)

Index

#1 BEST OVERALLFORECASTER - CANADA

http://desjardins.com/economics

https://www.desjardins.com/ressources/pdf/nf180724-e.pdf?resVer=1532438659000

ECONOMIC STUDIES

2AUGUST 2018 | COMMODITY TRENDS

OIL

The Organization of the Petroleum Exporting Countries (OPEC) agreement to restrict output succeeded in wiping out the huge oil surplus that had weighed on the market since 2015. What’s more, geopolitical issues in Venezuela, Libya and Nigeria, the lack of investments in Mexico and Angola as well as the announcement of new sanctions on Iran added more constraints to supply. Despite the fact that U.S. output continues to break records, oil inventories are still falling (graph 3). In fact, the oil market posted a deficit for five consecutive quarters and will only show a surplus in 2019, according to International Energy Agency (IEA) forecasts (graph 4). OPEC and other big producers recently agreed to increase their output to meet demand, which is reflected in the data for the last two months. Geopolitical factors persist, however. The situation in Iran is especially worrisome, as Iran exported about 2.2 million barrels a day in the first half of 2018 and the United States is threatening to impose sanctions on countries that fail to reduce their imports as close as possible to zero by November 4. Since the real impact of sanctions will only be clear once they’ve been applied, it is hard to predict the extent to which supply will be restricted.

The ongoing ramp-up of oil production in the United States helped counter the drop in production in some other countries. The question is: can this pace of growth be maintained? The

limited capacity of pipelines in the Permian Basin, which are currently pumping at full capacity, could temporarily hamper U.S. production growth. Furthermore, the Energy Information Administration (EIA) is calling for an annual increase of 1.00 million barrels per day in 2019, compared with 1.44 million in 2018. While this still points to robust growth, it is taking place against a backdrop of rising consumption. As a result, U.S. output may not be able to offset additional drops in production by the other major producers.

At the same time, strong demand is being threatened by a trade war, which would slow down global growth. For example, the United States is in direct conflict with China, one of its biggest oil customers. China purchased 20% of U.S. crude oil exports in 2017. Trade conflicts between these two countries could push China to turn to a different source to meet its energy needs. It would be tough for China to slash its U.S. oil imports completely, but if it replaced a portion of them with Iranian oil, for example, the spread between the WTI and the Brent barrel price could widen.

The more restricted oil supply spurred prices to react more sharply to news regarding crude oil, bringing more volatility to the markets. Prices remain relatively high, however. After reaching a peak of about US$75 a barrel, the price of WTI fell

EnergyUncertainty over the Oil Supply Spurs Volatility

FORECASTSThe oil market has been under pressure for some time, with some countries still having production difficulties and with new sanctions against Iran having been announced. Oil output in the United States continued to climb, reaching 11 million barrels per day in July, but this failed to stop U.S. stocks from continuing to slide. The price for a barrel of WTI (West Texas Intermediate) is hovering slightly below US$70 right now. We are forecasting an average price of US$67 for 2018.

GRAPH 3 Crude oil stocks are down, despite record output

Sources: Energy Information Administration and Desjardins, Economic Studies

United States

Millions of barrels/day

300

350

400

450

500

550

6

7

8

9

10

11

12

2013 2014 2015 2016 2017 2018

Mill

iers

Mill

iers

Crude oil production (left) Commercial stocks of crude (right)

In millions of barrels

GRAPH 4 The oil market deficit persists since 2017

* International Energy Agency (IEA) outlook based on stable production by Organization of the Petroleum Exporting Countries (OPEC). Sources: IEA and Desjardins, Economic Studies

85

88

91

94

97

100

103

-1.5-1.0-0.50.00.51.01.52.0

2012 2013 2014 2015 2016 2017 2018 2019

Surplus or deficit (left) Global consumption (right) Global production (right)

Millions of barrels/day Millions of barrels/day

Forecasts*


ECONOMIC STUDIES

back to below US$70 (graph 5). Nevertheless, the current price reflects an annual increase of nearly 39%. The price of Brent oil saw an even greater boost of 41% and recently settled at around US$74. WCS (Western Canadian Select) oil also experienced volatility, with oil production interrupted by maintenance work and a power outage in an oil sand mine. This temporarily brought the WCS price close to the WTI’s. However, now that production is gradually resuming, the spread is widening again due to the very limited capacity of pipelines in Western Canada. Our forecasts have not yet incorporated a total halt to Iranian exports or a trade war, but we continue to monitor these developments closely.

GASOLINE

Gas prices recently fell from their most recent peak of US$2.91 per gallon to approximately US$2.85, which is still relatively high (graph 6). Rising gas prices in the United States do not seem to have weighed too heavily on U.S. real consumption in the second quarter of 2018, which posted annualized growth of 4%. If oil prices stabilize at current levels, gas prices could remain quite high.

NATURAL GAS

Natural gas stocks are struggling to reach their five-year average, with the storage injection season already almost half over. Yet, prices are low at about US$2.90/MMBTU (Million British Thermal Units) (graph 7). In fact, the EIA expects stocks to end the season at their lowest level since 2008. Natural gas consumption is on the rise in the United States, which affects the accumulation of inventories. Consumption posted annual growth of 7.8% in May, the latest data available. This marks a peak for that month not seen since 2001, the start date of the current series. Production was also strong and the market seems more focused on the strength of supply rather than the strength of demand. Our forecast for 2018 is US$2.85/MMBTU. There could be an upward price shock if the winter proved to be very cold.

GRAPH 7 Natural gas prices struggle to rise, despite the sustained downtrend in stocks

MMBTU: Million British Thermal Unit Sources: Datastream and Desjardins, Economic Studies

Natural gas in the United States

In billions of cubic feet

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

-1,000-750-500-250

0250500750

1,000

2013 2014 2015 2016 2017 2018

5-year average spread in stocks (left) Price (right)

US$/MMBTU

GRAPH 6 Gas prices remain high

* Average WTI (West Texas Intermediate) and Brent prices. Sources: Datastream and Desjardins, Economic Studies

US$/barrel

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25

35

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2015 2016 2017 2018

Crude oil prices* (left) Gas prices in the United States (right)

US$/gallon

GRAPH 5 Brent and WTI oil prices are still relatively high

WTI: West Texas Intermediate; WCS: Western Canadian Select Sources: Datastream, Bloomberg and Desjardins, Economic Studies

Oil prices

US$/barrel

0

20

40

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2013 2014 2015 2016 2017 2018

WTI Brent WCS

ECONOMIC STUDIES


Prices for industrial metals usually correlate closely with the performance of the global economy. As of today, growth has been strong and the outlook remains bright, and yet the LME index for industrial metals has tumbled more than 10% since June (graph 8). The greenback’s appreciation weighed on metal prices, as its value has surged 6.4% since mid-april. What’s more, escalating trade tensions between the United States and its principal trading partners, particularly China, have rekindled fears of a global economic slowdown, which also weakened the LME index. If the Trump administration follows through on all of its threats and other countries retaliate, trade and manufacturing could be seriously impacted. Certain indicators pointing to a potential economic slowdown in China also contributed to the LME index’s recent weakness. That said, a trade war is not yet a reality and the economy is generally in good shape (graph 9), suggesting that the recent drop in industrial metal prices is merely speculative and temporary. We expect the LME index to recover despite the presence of downside risks.

ALUMINIUM

The sanctions introduced by the U.S. administration against Oleg Deripaska triggered more volatility on the aluminum market. They particularly impacted his company, United Company Rusal,

the world’s second-largest aluminum producer. A temporary lifting of the sanctions helped aluminum prices fall back from a peak not seen since 2011. At close to US$2,015 per metric tonne, the price is still high, but has fallen about 10% since the start of 2018 (graph 10 on page 5). Uncertainty over international trade seems to have taken over, with inventories still at very low levels amid strong demand. In such conditions, aluminum prices should instead rise or at least stabilize to the levels seen earlier this year. However, if the tariffs on aluminum stick and more are added to automobiles, demand for this metal could suffer and prices might drop. These issues will therefore have to be monitored.

COPPER

Due to copper’s more speculative nature, it was particularly affected by concerns about rising protectionism and the surging U.S. dollar. Prices had fallen consistently since last June, shedding 15% since the start of 2018, but they began to regain lost ground at the very end of July. The price of copper is now about US$6,150 per metric tonne (graph 11 on page 5). The market is relatively balanced and the recent weakness in prices cannot be explained by market fundamentals. Easing tensions could push copper prices higher. What’s more, if Chilean miners follow

Base MetalsUncertainties Seem to Be Driving Down Prices

FORECASTSThe recent drop in industrial metal prices appears to reflect the strong U.S. dollar and fears of an economic slowdown due to trade conflicts, rather than of a true economic deterioration. Global growth remains strong and stocks are still at relatively weak levels. In our view, this suggests that prices should rebound and drive the LME (London Metal Exchange) price index to post an average of 3,270 for 2018 as a whole.

GRAPH 9 Manufacturing is expanding, despite uncertainties over tariffs

Sources: Bloomberg and Desjardins, Economic Studies

Purchasing Managers’ Indexes

Index

46

48

50

52

54

56

58

60

62

JAN. APR. JUL. OCT. JAN. APR. JUL. OCT. JAN. APR. JUL.

United States Canada Euro zone United Kingdom China

2016 2017 2018

GRAPH 8 Metals prices are weakening, despite strong demand

LMEX: London Metal Exchange Index Sources: Datastream and Desjardins, Economic Studies

Index

5001,5002,5003,5004,5005,5006,5007,5008,500

5001,0001,5002,0002,5003,0003,5004,0004,5005,000

2000 2002 2004 2006 2008 2010 2012 2014 2016 2018

LMEX (left) Inventories of the six main metals (right)

In thousands of tonnes


ECONOMIC STUDIES

through on their threats to strike, price hikes could be even steeper, especially since other risks are looming over copper supply.

NICKEL

Nickel prices have been trending downward lately, like all the other metals we track. They have posted a gain of 8% since January 2018, however. Nickel is currently priced at about US$13,750 per metric tonne (graph 12). The stocks surveyed by the LME continued their downtrend and demand for this metal should keep climbing, since it is used to manufacture lithium batteries, such as those used in electric vehicles. Nickel prices could likely stage a comeback and climb even higher.

ZINC

Concerns surrounding trade spats exacerbated the downtrend in zinc prices, which began in February 2018. Zinc prices are now close to US$2,650 (graph 13), a decline of more than 20% since January 2018. While the stocks surveyed by the LME continue their consolidation, it would be surprising if zinc prices fully erased the decline suffered in recent months. The recent peaks were unsustainable over the long term, and the market should now be able to find its equilibrium again.

GRAPH 13 Zinc prices and inventories


US$/tonne

100

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500

700

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1,100

1,300

1,2501,5001,7502,0002,2502,5002,7503,0003,2503,5003,750

2013 2014 2015 2016 2017 2018

Prices (left) Inventories (right)


GRAPH 12 Nickel prices and inventories


US$/tonne

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13,000

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2013 2014 2015 2016 2017 2018



GRAPH 10 Aluminum prices and inventories


US$/tonne

1,0001,5002,0002,5003,0003,5004,0004,5005,0005,5006,000

1,400

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2013 2014 2015 2016 2017 2018



GRAPH 11 Copper prices and inventories


US$/tonne

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2013 2014 2015 2016 2017 2018



ECONOMIC STUDIES


GOLD & SILVER

The resilience shown by gold price last year and in early 2018, despite rising U.S. bond yields, was a big surprise. Things have begun to change in the last few months, however, and after four consecutive months of declines, gold prices fell from more than US$1,350 an ounce in early April to about US$1,210 an ounce (graph 14). There is little doubt that the spectacular about-face in the gold prices’ trend is directly tied to the surge in the U.S. dollar (graph 2 on page 1). The soaring dollar prevented

gold from playing its role as a safe haven in the face of concerns over a trade war. A period of consolidation for the greenback and stronger seasonal demand from India could give gold prices a bit of a boost in the months ahead. The uptrend in bond yields should continue, however, as investors seem to underestimate upcoming rate hikes in the United States (graph 15). This could keep downside pressures on gold prices in 2019.

PLATINUM & PALLADIUM

The sharp drop in gold prices did not spare platinum and palladium prices, which have also had to deal with more negative sentiment toward industrial metals in the last few months. Platinum prices suffered steep declines, even falling below US$800 an ounce temporarily (graph 16) for the first time since the 2008 financial crisis. As it would be tough for investor sentiment regarding platinum to worsen, several analysts are calling for prices to either stabilize or climb back up. Palladium prices have also fallen significantly in the last few weeks, but they remain higher than a year ago, unlike the prices of other precious metals.

Precious MetalsGold Prices Continued to Decline

FORECASTSAfter the sharp pullback in the last few months, gold prices could recover slightly in the short term. Nonetheless, we have downgraded our targets for 2018 and 2019. The U.S. dollar should remain relatively strong, with the Federal Reserve poised to keep tightening its monetary policy in the next several quarters. Gold prices should end the year at about US$1,250 and fall a bit lower in 2019.

GRAPH 16 Platinum and palladium prices


US$/ounce

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700800900

1,0001,1001,2001,3001,4001,5001,6001,7001,800

2013 2014 2015 2016 2017 2018

Platinum (left) Palladium (right)

US$/ounce

GRAPH 15 U.S. key rates could rise faster than investor expectations

Sources: Datastream, Bloomberg and Desjardins, Economic Studies

Effective federal funds

In %

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2015 2016 2017 2018 2019 2020

Federal Reserve leaders’ median forecasts

Implied rate based on futures contracts

GRAPH 14 Gold and silver prices


US$/ounce

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Gold (left) Silver (right)

US$/ounce


ECONOMIC STUDIES

FOREST PRODUCTS

After a spectacular surge in the spring, softwood lumber prices have fallen in recent weeks. As such, the benchmark price for U.S. wood fell from a historic peak of US$582/tbf (thousand board feet) at the beginning of June to below US$500/tbf (graph 17). Lesser rail transportation issues and signs that skyrocketing prices will encourage some wood producers to ramp up their activities, especially in the southern United States, have cooled fears of a wood shortage. Some weaker data on the U.S. real estate market, including a second straight quarterly decline in residential investment, are also raising a few doubts about demand for wood. Despite recent declines, wood prices remain high and nothing points to another steep drop unless the softwood lumber dispute is suddenly resolved.

AGRICULTURAL COMMODITIES

After climbing sharply in the spring, cereal prices declined as the summer began. The heat wave that left several regions sweltering, however, recently pushed up wheat prices over the levels reached in May (graph 18). Drought conditions in Europe led to a significant downgrade in this year’s expected global wheat harvest. Despite the hot summer, the situation remains more favourable for U.S. farmers, who are the leading corn and soybean producers. Crop conditions estimated by the U.S. Department of Agriculture are very strong (graph 19) and significantly better than last year’s conditions. Nonetheless, robust global demand for corn has help keep its price a little higher than last year. Soybeans are in a different situation, with prices suffering a steep drop due to the customs tariffs imposed by the Chinese government. These tariffs could restrict soybean consumption in China and force U.S. farmers to accept lower prices to offload their output elsewhere. The measures put in place by the U.S. government to support farmers affected by trade conflicts could limit adjustments on the soybean supply side. Changing weather conditions and trade tensions between the United States and China could trigger major cereal price swings in the next few weeks.

GRAPH 17 Forest product prices

tbf: thousand board feet Sources: Datastream and Desjardins, Economic Studies

US$/tbf

8509009501,0001,0501,1001,1501,2001,2501,3001,350

275

325

375

425

475

525

575

2013 2014 2015 2016 2017 2018

Softwood lumber (left) Pulp (right)

US$/tonne

Other CommoditiesA Less Favourable Summer

GRAPH 18 Cereal prices


US$/bushel US$/bushel

7891011121314151617

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2013 2014 2015 2016 2017 2018

Wheat (left) Corn (left) Soybeans (right)

GRAPH 19 U.S. poised to deliver strong crops

Sources: U.S. Department of Agriculture and Desjardins, Economic Studies

U.S. crop conditions on August 5, 2018

In %

0

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Wheat Corn Soybeans

Very poor Poor Normal Good Excellent

ECONOMIC STUDIES


SPOT PRICE

Aug. 9 -1 month -3 months -6 months -1 year Higher Average Lower

IndexReuter-CRB (CCI) 408.6 -2.6 -6.2 -1.8 -0.1 441.0 419.7 394.1Reuters/Jefferies CRB 193.0 -2.6 -5.2 2.4 6.3 206.4 192.1 175.4Bloomberg Commodity Index 85.1 -1.2 -5.5 -0.6 0.8 91.6 86.9 82.5Bank of Canada 464.5 -8.4 -8.1 4.3 11.9 513.8 453.3 406.1

EnergyBrent oil (US$/barrel) 72.4 -7.3 -6.3 14.1 38.4 80.5 66.5 50.6WTI oil (US$/barrel) 66.9 -9.5 -6.0 13.0 34.9 77.4 61.0 46.0Gasoline (US$/gallon) 2.85 -0.2 0.2 8.2 19.9 2.96 2.65 2.36Natural gas (US$/MMBTU) 2.95 4.3 7.7 14.1 2.3 3.63 2.88 2.55

Base metalsLMEX 2,983 -3.8 -10.5 -8.8 -2.4 3,500 3,254 2,934Aluminium (US$/tonne) 2,084 -2.9 -12.2 -1.7 3.2 2,541 2,149 1,960Copper (US$/tonne) 6,144 -3.7 -9.3 -8.5 -4.4 7,331 6,768 6,040Nickel (US$/tonne) 13,968 -1.1 0.8 8.0 30.3 15,688 12,890 10,157Zinc (US$/tonne) 2,654 -2.3 -13.3 -22.2 -9.1 3,606 3,162 2,502

Precious metalsGold (US$/ounce) 1,210 -4.1 -8.0 -7.8 -4.9 1,359 1,297 1,210Silver (US$/ounce) 15.3 -5.3 -6.7 -6.2 -7.5 18.2 16.6 15.3Platinum (US$/ounce) 824 -2.9 -9.7 -15.0 -15.8 1,020 929 798Palladium (US$/ounce) 900 -6.7 -7.8 -7.1 0.1 1,129 983 886

Other commoditiesLumber (US$/tbf) 463 -14.6 -11.8 -5.9 8.4 582 478 403Pulp (US$/tonne) 1,360 2.6 5.0 12.4 23.6 1,360 1,215 1,100Wheat (US$/bushel) 5.67 8.0 11.2 24.1 22.5 5.73 4.64 3.89Corn (US$/bushel) 3.35 4.4 -10.7 -0.9 -2.6 3.78 3.34 3.06Soybean (US$/bushel) 8.65 5.4 -11.5 -8.7 -8.1 10.33 9.37 7.84

CRB: Commodity Research Bureau; CCI: Continuous Commodity Index; WTI: West Texas Intermediate; MMBTU: Million British Thermal Unit;LMEX: London Metal Exchange Index; tbf: thousand of board feetNOTE: Currency table base on previous day closure.

TABLE 1Commodities

VARIATION (%) LAST 52 WEEKS

2016 2017 2018f 2019f

Target: 67 Target: 70(range: 65 to 69) (range: 60 to 75)

Target: 2.85 Target: 3.10(range: 2.75 to 2.90) (range: 2.60 to 3.90)

Target: 1,280 Target: 1,230(range: 1,260 to 1,300) (range: 1,150 to 1,350)

Target: 3,270 Target: 3,550(range: 3,100 to 3,350) (range: 3,100 to 4,100)

LMEX index—base metals 2,375 2,969

f: forecasts; WTI : West Texas Intermediate; MMBTU : Million British Thermal Unit; LMEX : London Metal Exchange IndexSources: Datastream and Desjardins, Economic Studies

Natural gas Henry Hub(US$/MMBTU)

2.55 3.02

Gold (US$/ounce) 1,248 1,259

TABLE 2Commodities prices: History and forecasts

ANNUAL AVERAGE

WTI oil (US$/barrel) 43 51

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Tumbling Base Metal Prices Are Out of Sync FORECASTER