Threadneedle’s Donora discusses the outlook for commodities in a slow-growth world

David Donora, head of Commodities at Threadneedle Investments, says supply and demand factors point to stability in prices.

Q: Is the global growth outlook strong enough to support a positive view on commodities?

The outlook for global growth is certainly muted and, while this is partly due to deleveraging and the eurozone debt crisis, it is also partially a result of resource constraint. The world does not produce enough commodities to support uniformly strong growth in all economies, so commodity availability is a major regional differentiator. But, despite our modest estimates for global growth, we still believe the global economy will generate significant demand for commodities. For example, 2.5% global GDP growth equates to around 1.5 million barrels per day of additional oil demand on a current global demand of 90 million barrels per day. It is a similar picture in other areas such as copper and food, so the muted growth we are expecting should still underpin prices in several areas.

Q: What are the regional winners and losers from commodity availability?

North America is a major winner, as it is benefiting from oil and natural gas prices that are significantly lower than is the case for its global competitors. US natural gas prices in particular have fallen as a result of technological advances, with horizontal fracturing techniques allowing access to large volumes of cheap gas. This has led to US natural gas prices falling to less than $3/MMBTU compared with the nearly $17 that Japan pays for imported liquefied natural gas.
Similarly, West Texas Intermediate (WTI) oil is currently considerably cheaper than Brent Crude, which is used across Europe, and the US also enjoys abundant supplies of inexpensive coal. This equates to a huge cost advantage for US industry and consumers and is one reason why we expect the US to post superior growth to its developed world peers in 2012 and 2013.

Q: What do you see as the main themes driving commodity markets in the coming months?

I think spot markets will remain tight. Commodity companies that we speak to are often cautious about investing in new capacity given the uncertain economic outlook and the looming presidential election in the US. It takes a long time and a lot of money to open a new mine or exploit a new oil field, so there is quite good visibility on future supply growth. We don’t foresee much growth in supply over the next year or two, which means that supply and demand should remain balanced.

We are also likely to see further volatility in the market. Like other risk assets, I think commodities are going to be driven by the battle between slow growth and risk aversion on one side and excess liquidity on the other. Central banks stand ready to provide additional liquidity to support markets and experience shows that money created through quantitative easing normally ends up in risk assets. Commodities have certainly benefited from this in the past. But this liquidity will only be unleashed if markets go into crisis mode, perhaps as a result of the eurozone taking a turn for the worse, so we certainly expect more two-way volatility.

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