Commodities brace for tough 2016 in Asia

" Agricultural markets are showing some of the early signs typical for the bottom of the price cycle."
Mark Pervan & Paul Deane, Global Head of Commodity Research & Senior Agriculture Economist at ANZ

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Real activity indicators from China remain unpromising for commodities and globally there have been low levels of investment. Slowing Chinese growth remains the big drag on the sector and weaker-short term growth is expected ahead.

Industrial-based commodities remain the weakest performers. In better news, investment funds have already priced in a lot of the negativity, as well as expected changes to US monetary policy.

Structural reform will also be a headwind. Credit restrictions are unlikely to be eased until some headway is made on consolidation (essentially steel mill bankruptcies) and rising environmental controls will likely inhibit any new capacity into the market.

The key Chinese steel exports will be closely watched. Volumes boomed in 2015, putting enormous strain on steel and iron ore prices. We think the dynamic could change in the next six months.

Rising trade protectionism – particularly a raft of new US anti-dumping duties - could all but close the Chinese steel export arbitrage window, and trigger the start of long overdue consolidation in the domestic steel supply.

Crude oil markets will remain subdued in 2016, though prospects for a recovery look better in the second half of the year. OPEC's decision to effectively let go of their production quota means the market cannot rely on the bloc to support prices.

US crude oil supply growth has been pivotal in shifting the new equilibrium price for oil. For 2016, of equal importance will be how producers respond to life with lower prices.

Three dynamics bear close watching in the year ahead: operating costs, hedging levels and use of back logged (or spare) wells. All three point to lower oil production emerging in the second half the year, although any decent price gain will be quickly capped by idled well capacity being brought back on quickly.

AGRI AT THE BOTTOM

In better news, agricultural markets are showing some of the early signs typical for the bottom of the price cycle.

Global production is more closely aligning with demand in a number of sectors. Markets are no longer expecting to see large increases in grain and oilseed stocks - as has been the case in recent years.

In sugar, the next 12 months should see the first significant decline in global stocks since 2008. Grains are likely to be one of the better risk/reward trades in the agri sector in 2016. At current grain prices markets are starting 2016 with little risk premium for weather or trade disruptions in grain markets.

US corn and hard red winter wheat markets look particular oversold based on fund positioning heading into 2016 are and to a lesser extent Chicago wheat. One trigger for fund buying to re-emerge is the potential for lower wheat production from the Black Sea in 2016.

A warm and dry autumn has left the area planted to winter crop in the Ukraine at the lowest level and in the poorest condition in years.

On the flipside, the sugar market looks heavily overbought and prices vulnerable should funds change tack. The risk to sugar prices in 2016 is an unwinding of fund positions at some point.

Mark Pervan is Global Head of Commodity Research and Paul Deane is Senior Agriculture Economist at ANZ