Euro crisis obscuring positive fundamentals in commodities, says Threadneedle’s Donora
David Donora, head of Commodities at Threadneedle, says that fundamental drivers of commodities prices remain in play despite the near term focus on the European sovereign debt crisis.
The ongoing debt crisis in Europe is dominating sentiment across all markets, including commodities. However, there are still several positive fundamental factors underpinning commodity markets when we look past the immediate short term. Among the key themes driving our thinking are: the trend towards urbanisation in emerging markets, the tightness in supply of a number of key commodities including oil; and differentials in natural gas pricing across geographies.
Urbanisation trend to continue
Urbanisation remains a powerful theme across the emerging markets, with significant implications for investment strategy. The process is still at an early stage and has decades to run. For example, around 2% of the US workforce is employed in farming, while the equivalent figure in China is still more than 30%. Currently 45% of the Chinese population lives in cities; we expect that to increase to more than 65% in the next 20 years. And the proportion of Indian urban dwellers is set to rise from 25% to 35% over the same period. In total, more than three billion people are forecast to move into cities globally by 2050. This has a significant potential impact on commodity markets.
Changing drivers in urbanisation theme
So far, the urbanisation theme has focused mainly on infrastructure spending, as these growing economies build roads, railways and cities. This is the driver behind demand for the likes of steel and copper. As these economies mature, however, the balance of commodity demand will shift towards consumer spending. This should see a growing intensity of demand for energy, meat and grain commodities. We are already seeing this in China, and as a result we predict huge growth in food demand for decades to come.
Tight oil markets supportive for prices
Growing emerging market demand is structurally supportive not just for food but for energy, and this is positive for oil prices over the long term. With oil demand at around 91 million barrels a day, and only 2 million barrels a day of spare capacity, this is a major long-term issue. There are also shorter-term factors that mean oil markets will remain very tight. Geopolitical disruptions have become a fact of life for oil markets in the past year, with supply disruptions not just down to the Arab Spring and Libyan conflict, but also in Africa (Nigeria, Angola and Sudan) and South America (Argentina and Brazil). While there is significant growth in production in the US and Canada, we believe it will take longer than the market expects for this new output to reach end users as infrastructure and distribution struggles to keep pace with production growth.
America’s energy advantage over Europe
As a result of new discoveries and technology developments, America’s increasing oil production is giving the US a cost advantage over Europe. Brent and WTI crude oil prices had moved in tandem for 30 years, but they diverged markedly from 2010. Brent crude is now structurally higher than America’s WTI crude oil price, often by $10 a barrel or more. European production growth is well behind that of the US and could take 10-20 years to catch up. In addition to oil, the US also has an abundance of coal and natural gas. This gives the American economy a cost advantage over European economies, in areas such as petrochemicals, agriculture and manufacturing.