Commodity Correction Risk Rising

Includes: DBC, GCS
by: FP Trading Desk

Recession? What recession? Commodity prices have been on a roll for months. Traders have focused on Chinese restocking and ignored the, shall we say, plentiful global inventories.

But the party could end soon. RBC Capital Markets analysts Fraser Phillips and Adam Schatzker wrote that the near-term outlook for commodities has become uncertain.

"Chinese restocking may be coming to an end, and while the outlook for economic growth and commodity demand outside of China is improving, it is unclear whether growth will be strong enough to offset any slowing in China," they wrote in a note to clients.

They also pointed out that higher commodity prices are pushing companies to restart idled production, which could lead to higher inventories in the near-future. Ultimately, strong demand growth will be needed in order to eliminate the excess supply in the system, they noted, mentioning copper as one exception.

On the positive side, they wrote that cost support should limit the downside pressure. Last fall, prices for many commodities fell far below the marginal cost of production, and most experts do not expect that to happen again.

Mr. Phillips and Mr. Schatzker wrote that the commodity rally may be extended for a "time" as leading economic indicators show improvement. But uncertainty about the "strength and breadth" of the demand recovery increases the likelihood of a correction.

They recommend uranium, and favour copper among all the base metals. They are less positive on zinc because of increased Chinese mine supply and higher capacity forecasts.