Credit Suisse Macro View Commodities: Sweet Spot of Global Demand

Commodities should continue to perform well in 2011, in our view, with global growth likely to remain above average. From a fundamentals perspective, we expect differentiation among commodities to grow, with the strongest performance by those commodities used heavily in construction/infrastructure and production, as well as agriculture, with crude oil and steaming coal remaining more range bound. We believe that this is the most constructive combination for global macro stability. If energy prices were also to break significantly higher, we would be concerned about the potentially destabilizing consequences for corporate profitability and the recovery trend.

The macro risk environment is likely to continue to impact short-term commodity price movements, with the key euro/dollar relationship at the forefront. But as has been the case in 2010, as it becomes evident that the global recovery is continuing, we expect the correlation between the dollar and commodity prices to continue to weaken gradually.

While global GDP growth is expected to slow a little, we expect the composition of global growth to remain supportive of commodities, with activity remaining strongest in the emerging markets and the goods sectors of the G7 (both of which are commodity intensive).
• The 2010 global industrial production slowdown looks to have come to an end, with growth likely to strengthen into 2011 (with China remaining strong and the G7 continuing to recover).
• Similarly, the global rebound in global fixed asset investment is likely to continue. While the level of global GDP remains well below trend, the surge in Chinese investment in 2009 absorbed much of the global spare capacity in construction commodity markets. We expect China to continue to grow strongly off the new elevated base (as has been the case so far this year), with investment continuing to recover in the G7 economies (Exhibit 5).

We thus expect those commodities most leveraged to global construction/production that also have ongoing supply constraints to perform the strongest over 2011. These include base metals, particularly copper (+30% year average), and iron ore (+11%).

Despite recent gains, on a medium-term outlook our favorite industrial metal remains copper: it should benefit from strong fixed asset investment, is supply constrained, and has low and declining levels of inventories, suggesting that if demand surprises to the upside, prices could move sharply higher. Iron ore prices are likely to remain high, while metallurgical coal prices are likely to move higher, possibly significantly.

The platinum group metals also should offer strong leverage to a recovery in consumer confidence and spending, with palladium outperforming with a 52% rise in prices. While demand for energy commodities such as oil, natural gas and steaming coal, is likely to also remain robust, these commodities do not face imminent supply constraints. Consequently, they are not expected to perform as strongly. Among the hydrocarbons,
those leveraged to the movement of goods, which includes gasoil and diesel but not crude oil per se, should also perform the best. US natural gas should continue to lag (flat) while European natural gas should see tightened conditions in 2011.

In addition to strong demand, commodities are also likely to benefit from continued uncertainty surrounding the likely impact of increases in the US and global money supply (some think it won’t work and that the G7 economies will slip into deflation, while others worry about hyperinflation). We expect this to continue to support precious metals as investors seek out the “security of physical assets”, with gold rising 22% (vs. 23% in 2010), and silver up around 50% (vs. 25% in 2010).

The expectation of continued low interest rates in the G7 should also support commodities. Near-zero rates eliminate one of the normal disincentives to investing in commodities – the fact that they do not pay yield or dividend. By committing to keep rates low, the Fed has all but eliminated a significant element of the cost of holding commodities, increasing the attractiveness of commodity investment across the complex.