Commodity bears are testing nerves of producers. Several commodity producers, especially those related to metals and US shale, have blinked and cut production. However, there is always a limit to the extent they can cut production. 
Prices are at multi-year lows — metals around 7-8 year lows, oil at 12-year lows. Gold and silver are no exceptions and so are other commodities like iron ore, steel and coal.
Most resource commodities are in a bear market, down significantly from their peaks, largely due to lower demand. The criteria to indicate whether commodities are in a bear market is when a commodity is down 50% or more from its peak or is around its long term low levels.
Gnanasekar Thiagarajan, Research Director, Commtrendz, a risk advisory firm said, “Commodities have a larger cycle of weakness and strength driven by demand/supply, while equities have larger sentimental implications. However, unlike equities, commodities have an intrinsic value”.
For example, in case of crude oil, most options traders on global exchanges are writing options of $20 and below per barrel indicating that $20 level is imminent.
The price of almost all metals has consistently remained below their cost of production. There is a limit to produce more at these levels and production cuts will get reflected in prices over a period of time.
According to Gnanasekar, even though oil has almost seen its worst and when the entire market is looking for a certain level, which is $20 as reflected in position build up in option market, the unwritten rule suggests that such a level may not come. Even some veteran observers of crude oil market say that in 1999-2000, when oil fell below $10 a barrel, everyone was looking for a level of $5 which never happened.
However, by the time oil forms a bottom, it would have impacted fortunes of many countries. Interestingly, petro dollars are invested in US dollar largely and withdrawal by oil producing countries from their currency reserves is yet to begin which would further pressurise the dollar. A weak dollar however may spell good news for commodities.
Andrew Leyland, Director — Metals & Mining Consulting, Wood Mackenzie, a London based commodity research and advisory firm said, “The answer to the question that how long metals prices can remain below production costs, depends on the stomach of metals companies to operate at a loss. A key change from the 1990’s is that more natural resource production comes from countries (especially China) where employment, not profit, is the number one consideration for the owners of these assets, whether they are steel mills, aluminium smelters or copper mines. In that respect we could be looking at lower prices for a longer period.”
International Copper Study Group had earlier projected deficit in copper to widen in 2016. However, its latest data suggest, “world mine production is estimated to have increased by around 3.5 % (520,000 tonnes) in the first ten months of 2015 compared to 2014”.
Gnanasekar believes that since US raised rates, globally carry trades started unwinding and metals and other asset classes corrected. However, global slowdown fears would put pressure on Fed not to raise rates faster. In this scenario, “there could be a risk aversion in base metals,” he added.
After several rounds of production cuts by miners of base metals, the market is now waiting for some revival of demand may be for strategic reserves. However, prices are yet to see even a relief rally.
Andrew Leyland said, “For steel, iron ore, copper and aluminium, Wood Mackenzie expects further declines in benchmark average annual prices in 2016. Whether the coming year proves to be a turning point in these markets rests largely on the markets ability to reduce oversupply. Any saviour from the demand side of industrial metals markets looks increasingly unlikely.”
Source: Bloomberg
Compiled by: BS Research Bureau