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Summary of COMMODITIES WEEKLY - 13 November 2014

Core Content Overview

This report provides an analysis of key commodities markets, focusing on copper, energy, precious metals, and base metals. It outlines the current state of these markets, including price trends, forward curve dynamics, and geopolitical and economic factors influencing supply and demand.

Main Points on Copper

• Copper Price Dynamics: Copper prices have fallen, but the forward price curve has shown a backwardation, which is counter-intuitive since theory suggests backwardation should occur during rising prices.
• Role of Chinese State Reserve Bureau (SRB): The SRB is a key player in shaping the copper forward curve by accumulating large stocks at lower prices.
• Import Data: Chinese imports of unwrought copper and products increased to 400,000 tonnes in October, with SRB placing orders for 150-200,000 tonnes of copper cathode.
• Forecast: The SRB may continue purchasing until prices fall below $6,000/tonne. This could lead to a more extreme backwardation in the forward curve.
• Market Outlook: The copper market is expected to move from backwardation into contango in 2015, with an average price forecast of $6,335/tonne.
• Stock Accumulation: Exchange copper stocks have fallen by ~230,000 tonnes, but Chinese bonded warehouses remain stable, indicating SRB activity is masking a broader surplus.
• SRB's Strategic Stockpile: The SRB may have accumulated over 1.5mn tonnes of copper, with the potential to hold up to 2mn tonnes under its mandate.

Energy Market Analysis

• OPEC Dynamics: OPEC members are divided on the need for output cuts, with stronger members downplaying the necessity, while weaker members face financial strain from falling oil prices.
• Output Forecasts: OPEC crude demand is expected to fall from 30.2mn b/d in 2014Q4 to 28.4mn b/d in 2015Q1, with an average of 29.2mn b/d for the year.
• Nigeria's Challenges: Nigeria's 2014 budget assumes a crude price of $77.50/bbl and output of 2.39mn b/d, but actual output is below this, and falling prices are expected to worsen its financial outlook.
• Venezuela's Situation: Venezuela restructured oil debt repayments to China, reducing the mandatory 330,000b/d. The country is still struggling with the impact of lower oil prices.
• Ecuador's Budget Deficit: Ecuador's budget deficit has increased to 4.7% of GDP in 2013 and is expected to rise further in 2014, making 2015 potentially more challenging if oil prices fall.
• Investment Trends: Oil companies may shift focus to natural gas, especially as US LNG export facilities near completion. Lower oil prices may lead to a 10% drop in US tight oil investment.
• Transocean's Write-Down: Transocean reported a $2.6bn write-down due to reduced offshore exploration spending.
• OPEC and Iran Talks: P5+1 and Iran are discussing the nuclear program, with Russia and Iran agreeing to build up to eight nuclear reactors in Iran.

Precious Metals Insights

• Gold Leasing and ETF Outflows: ETF outflows have led to physical scarcity in London, pushing lease rates up from 8bps to 34bps, the highest since 2009.
• Gold Premiums: Gold premiums in Asia have risen, indicating increased demand for smaller bars and jewelry, which are less available for leasing.
• Switzerland's Gold Trade: Switzerland exported 2,777 tonnes of gold in 2013, with 23% going to China and 25% to India in the first nine months of 2014. This reflects a shift in gold ownership from western vaults to Asian markets.
• Central Bank Demand: Central bank demand for gold has slowed since 2013, with only 350 tonnes added in the past 20 months compared to 480 tonnes in 2012.
• Future Volatility: Reduced gold availability for leasing, combined with increased hedging demand, is expected to lead to more volatility in gold lease rates.
• Gold and the Rand: The weakening South African rand has benefited local producers, reducing operating costs.

Base Metals Highlights

• Copper Premiums: Codelco offered a $133/tonne term premium for 2015 deliveries to China, down from $138/tonne in 2014 but still higher than Pan Pacific's $115/tonne.
• Aluminium Market: Despite the LME's efforts to reduce warehouse queues, aluminium producers are maintaining "supply discipline," keeping premiums high.
• LME Reforms: New LME rules aim to reduce warehouse queues to 50 days, with additional constraints on aluminium warehouses. These reforms could help bring premiums closer to "normal" levels.
• Mongolia's Political Changes: The removal of Prime Minister Norov Altankhuyag due to falling commodity prices may lead to a more cooperative stance with Oyu Tolgoi, potentially freeing up funding for the mine.
• Lonmin's Costs: Lonmin reported a $326mn pre-tax loss, with rising labour costs and a target rate of return of at least 15% for new investments.

Key Information

Key Takeaways

• The SRB's strategic purchases are influencing copper's forward curve, creating a backwardation despite falling prices.
• The shift in gold ownership from Western vaults to Asian investors is affecting lease rates and physical availability.
• OPEC's internal divisions are expected to persist, with weaker members facing financial pressure.
• Energy investment is likely to shift towards natural gas, especially in the US, due to the potential for higher long-term returns.
• LME reforms may help reduce warehouse queues and bring premiums closer to "normal" levels.
• Mongolia's political changes could lead to improved relations with Oyu Tolgoi and more funding for the mine.
• Lonmin's financial struggles highlight the challenges faced by South African producers, especially with the weakening rand and rising costs.