Bears testing nerves of commodity producers

With prices hovering around multi-year lows, producers are either cutting down output, even as they wait for a relief rally

Similar to the equity class, bears are testing nerves of commodity producers too, which have already been forced to cut output. However, there is a limit to the extent they can cut output. Even then, prices are at multi-year lows, like metals which are at 7-8 year lows, oil at 12 year lows and so are gold, iron ore and coal. The last few days have seen some gains, but its no respite for producers.

Most resource commodities are in a bear market, thanks to lower demand. Commodities are said to be in a bear market when prices are down 40-50 per cent or more from peak. While there could be more pain going ahead, the pain could last for a prolonged period.

Gnanasekar Thiagarajan, research director, Commtrendz, a risk advisory firm says, “Commodities have a larger cycle of weakness and strength driven by demand/supply, while equities have larger sentimental implications. But, unlike equities, commodities have an intrinsic value.”

In case of crude oil, most options traders on global exchanges are writing options of $20/barrel and below indicating that $20 level is imminent. Although crude has seen some gains recently on hopes of output cut, supplies will still exceed demand. Metals are equally in bad shape with prices below costs.

However, there could be some sporadic bounce in prices, say experts.

Gnanasekar says that oil has almost seen its worst and when the entire market is looking for a certain level ($20), the unwritten rule suggests that such a level may not come. Another expert says that in 1999-2000 when oil fell below $10 a barrel, everyone was looking for a level of $5 which never came.

  Whether the downtrend will reverse and sustain in contrast to most expectations will only be known later. The other question is whether prices can sustain at higher levels on mere production cuts at a time when demand remains weak.

On metals, Andrew Leyland, director - metals & mining consulting, Wood Mackenzie, a London-based commodity research and advisory firm says, “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 1990s 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. So, we could be looking at lower prices for a longer period.”

What’s more, after several rounds of production cuts by miners, prices are yet to see even a relief rally. “A lot hinges on the market’s ability to reduce oversupply. Any saviour from the demand side of industrial metals markets looks increasingly unlikely,” says Leyland.