Morgan Stanley Goes Bearish On Commodities Amid Brexit, China Slump
There is a bull and bear case for commodities, a Morgan Stanley Global Metals Playbook notes. The June 27 report takes a decidedly bearish view of hard commodities in general. It issues a mostly neutral or even more pronounced bearish take on commodities in general, with one exception. The report contrasts their recommendation from last October, which was bullish. Commodities, as measured by the S&P GSCI Index, mostly sold off from October 2015 to February 2016, when they rallied.
Morgan Stanley and the predominate bear case for commodities
Heading into the third quarter of 2016, commodity markets could find difficulty. In particular, the 67-page report takes a most negative look at diamonds, giving it the most bearish rating. Other bearish ratings include pure industrial commodities iron ore steel as well as uranium, mineral sands and metallurgical coal used in steel production. The one commodity with a bullish outlook is zinc, which has medical uses.
The bear case Morgan Stanley makes for hard commodities has three primary points. Brexit, at the top of the list of performance excuses across a variety of financial assets, is at issue.
The bank’s analysts point to an EU exit process that “lacks resolution and clarity.” This will result in investment declines across Europe, which will impair industrial activity and growth. Even though the details of a potential exit are not known, the report nonetheless had a degree of certainty. The declining trend in economic activity that will result from a Brexit will lower commodity demand, is the logic. But it isn’t just Europe where this problem will dampen commodity demand.
China, which until the Brexit was the primary reason given for both economic and commodity weakness, is back. The report noted that further currency “depreciation/devaluation in line with basket of currencies, undermines commodities demand in China.” As the currency is devalued, the cost of commodities goes up in local terms, reducing demand. The report predicted that such activity would impair trade-led growth ex-China, prompting a wave of monetary easing worldwide. A rising US dollar was also cited as a factor in dampening commodity demand.
Bull case for commodities includes amicable Brexit divorce, growing economy and supply issues
While the report was decidedly bearish on most commodities, it did make a bull case, particularly for hard commodities with potential supply issues.
The bull case for commodities is, in some respects, the opposite of the bear case.
A key point is that the Brexit divorce between the UK and EU results in an amicable split and the transition takes place with a high degree of transparency. Under this base case it would have a negligible impact on trade flows. Overall, a rise in the global economy, benchmarked by global GDP growth, lifts the economy. In this environment inflation, something not seen as of late, is apparent but effectively managed.
All the talk of fiscal stimulus results in the US and China deploying commodities-intensive capital infrastructure construction programs. While potential European fiscal stimulus was not mentioned in the report, such increased demand considered by other economists would only increase commodity prices.
Supply factor could play into the hands of commodity bulls
While the demand factor was a key point, it is also supply that was a factor in picking commodity winners. “Zinc’s steel-led demand hike and collapsing mine supply is a winning combination,” the report noted. “Zinc’s price has defied expectations to emerge as 2016’s (year-to-date) top performing base metal signal in 1H (+27%yoy to >$2,000), up on a ‘double-whammy’ of a widely anticipated mine supply shortfall (exiting big mines; Glencore’s price-related mine production cuts, 2015) + robust steel production rates (galvanizing).”
Copper and nickel have similar supply issues even though the report rates them at the low end of neutral.
“China’s local mining industry reform makes thermal coal intriguing again,” the report said. Like copper and nickel, the report rated thermal coal at the low end of neutral, one notch above bearish.
In regards to what is considered a hedge, gold and silver, the analysts were “warming” to the idea “given the cooling macro-outlook.”
Gold’s safe haven status is intact: new Brexit uncertainty + US Fed’s languishing rate hike cycle + China’s expanding debt load all enhance market anxiety, and the need to preserve capital. Price is up 25%ytd in this environment, up initially on the back of the Fed’s postponement of 2016’s first rate hike. Britain’s vote to depart from the EU promises to be the dominant short-term gold price driver now.
Detractions in this metal include physical demand slipping in India and central bank buying slowing.
Numerous commodity researchers have opined that the commodity rally is fake and that the bull run is ending. While the points of analysis differ to various degrees, a common theme among bank researchers is forming.
Note: The author of this article is Mark Melin.
Category: Commodity Trading
