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In its latest monthly report Scotiabank outlines four key points, suggesting that there’s one main risk for global commodities demand right now.

Scotiabank’s Commodity Price Index fell 0.7 percent month-on-month in July, drawn downward by “weakness in the metals sub-index.”  

According to the firm, commodities prices have been pressured by two main factors: a drop in macro sentiment and a stronger US dollar. Base metals have taken the brunt of the damage, but other commodities have also been affected.

In the bank’s opinion, the trade war between the US and China is the top risk for commodities demand right now, although it does see commodities prices recovering as the second half of 2018 continues.

Scotiabank shares four points that explain that outlook in its report — here’s an overview of those ideas.

1. Commodities prices should recover as the year continues

Scotiabank says that after gaining for two and a half years, commodities prices have been stopped in their tracks, with base metals prices down by over one-fifth since June, gold sinking below $1,200 per ounce and oil facing demand concerns.

“Raw material prices have disconnected from fundamentals and commodity contracts remain depressed by the combined weight of deteriorated macro sentiment and a stronger US dollar,” the firm says.

However, says Scotiabank, “[w]hile there are signs that materials-intensive activity is slowing, the global economy remains strong and economic growth broad based.” Its expectation is that commodity prices will recover through to the end of the year.

2. But the trade war is the biggest risk for commodities demand

The ongoing trade war between the US and China is “the most serious threat to the global demand for commodities,” says Scotiabank, noting that “it is unlikely that the conflict will be resolved anytime soon.”

As the firm explains, the dispute could slow industrial activity in China, which is responsible for over half of global demand for most industrial metals. That’s even more of a concern given that before the trade war emerged construction activity in the country was already easing. Now, says Scotiabank, policymakers in the country must choose between maintaining the current deleveraging bias or introducing new stimulus measures to offset US tariffs.

But again, the bank expresses optimism about growth on a global scale. “[E]ven with a trade war raging in the background, we believe that global growth will remain resilient,” it says.

“Mining companies are putting forward a similar thesis, with the world’s largest miner saying that while trade disputes have increased the risks to economic momentum, they do not rise to a ‘recessionary level shock’ to the global system.”

3. Commodities are being driven by bets that growth will be derailed

“[C]ommodities are currently being driven by bets that growth will sour,” says Scotiabank — despite the fact that economic fundamentals are “mixed but still encouraging.”

In the bank’s opinion, “[i]t will take a major development to shake this macro cloud hanging over commodity prices.” It cites speculative shorting as the main culprit behind lower commodity prices and says that specific commodity fundamentals are being blunted by macro headwinds.

The firm points in particular to lackluster recent performances from copper and zinc. In terms of the former, it notes that while the red metal’s summer “was supposed to be filled with intrigue related to labour contract turnover at major Latin American mines,” trade war news ultimately derailed any upward momentum that could have caused.

Meanwhile, “zinc’s performance has been even less inspiring.” But Scotiabank notes that though its fundamentals have “slipped slightly from their early-year tightness,” zinc’s current rout is overdone.

4. The Trans Mountain verdict was a hit for Western Canada’s oil market

Scotiabank’s final point in the report relates specifically to oil, which it says “is being held back on macro and demand growth fears.”

The bank also comments on the Canadian court of appeal’s recent decision to overturn approvals for the Trans Mountain Pipeline Expansion Project (TMEP). It describes the news as a “significant blow” for the Western Canadian oil market, saying, “the latest TMEP ruling likely extends the period of sub-optimal WCS discounts — linked to breakeven oil-by-rail economics ($18 –20/bbl) — by at least a year.”

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Securities Disclosure: I, Charlotte McLeod, hold no direct investment interest in any company mentioned in this article.



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