Scotiabank's Commodity Price Index Rallies in March

TORONTO, April 29, 2013 /CNW/ - Scotiabank's Commodity Price Index rose by 1.6% month over month (m/m) in March, after edging down in February, and inched up slightly in the first quarter of 2013 from the fourth-quarter average. However commodity markets remain skittish, with a sharp selloff in gold in mid-April and softer base metal prices, after the release of China's slower-than-expected first-quarter GDP advance, 7.7% year over year (yr/yr), down from 7.9% in 2012:Q4.

"Firmer overall prices in March were likely a surprise to financial markets," said Patricia Mohr, Scotiabank's Vice President of Economics and Commodity Market Specialist. "The advance was led by the Oil and Gas Index (+6.8% m/m), with gains in Western Canadian Select (WCS) heavy oil, natural gas export prices from Canada to the U.S. and liquefied petroleum gas (LPG) prices in Edmonton and Sarnia."

For more details about the Scotiabank Commodity Price Index, please read the full report below. Highlights include: a gold price sell off in mid-April was triggered by a potential Cyprus bullion sale; Asian contract price for premium-grade hard coking coal posts surprising gain in 2013:Q2; Market conditions for copper and nickel are likely to be lackluster in the next several years, as new mine supply comes on stream, however, the "Super Cycle" in base metals will return in the second half of the decade, with zinc the next big base metal play.

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Scotiabank's Commodity Price Index Rallies In March

Scotiabank's Commodity Price Index rose by 1.6% month over month (m/m) in March, after edging down in February, and inched up slightly in the first quarter of 2013 from the fourth-quarter average. However commodity markets remain skittish, with a sharp selloff in gold in mid-April and softer base metal prices, after the release of China's slower-than-expected first-quarter GDP advance, 7.7% year over year (yr/yr), down from 7.9% in 2012:Q4.  The All Items Index remains 15.7% below the April 2011 near-term peak, just prior to the advent of financial market concern over excessive eurozone sovereign debt and the likely negative impact on global growth.

Firmer overall prices in March - likely a surprise to financial markets - were led by the Oil and Gas Index (+6.8% m/m) - with gains in Western Canadian Select heavy oil (WCS), natural gas export prices from Canada to the U.S. and liquefied petroleum gas (LPG) prices in Edmonton and Sarnia.  NYMEX natural gas prices climbed to US$4.41 per million metric British thermal units (mmbtu) on April 19 - the highest since July 2011 - on prolonged wintry weather in the U.S., increasing space heating demand and cutting U.S. gas-in-storage 4.2% below the five-year average for this time of year.  Natural gas prices were only US$2.53 a year ago.

The price of WCS heavy oil also rose from a mere US$58.38 per barrel in February to US$66.73 in March and about US$68 in April - a welcome development for Alberta's hard-pressed steam assisted gravity drainage (SAGD) bitumen producers.  The discount on WCS heavy oil off West Texas Intermediate (WTI) narrowed markedly from a record high of US$36.94 in February to US$26.23 in March, to US$23.07 in April and an even lower US$13.90 for May (TMX/Shorcan Energy Brokers) - partly due to a seasonal pick-up in demand for Western Canada's crude, as U.S. Midwest refineries returned from an unusually high level of maintenance in early 2013.  (Please see below for further comments on this development.)

The Forest Products Index also strengthened in March, rising 2.2% m/m.  Western Spruce Pine Fir 2x4 lumber prices in the B.C. Interior (the bellwether for North America) jumped as high as US$408 per thousand board feet (mfbm) mid-month, while Oriented strand board (OSB) prices in the U.S. North Central region climbed to US$430 per thousand square feet, approaching the previous peaks during the heydays of 2004 (US$460 and US$520 respectively).  Profit margins were stellar at 25-30% on lumber and 54% on OSB.  While prices have been checked in mid-April by some inventory build - during the seasonally slow first quarter - we expect prices to rebound in the third quarter and to move irregularly higher through first-half 2015 (over US$450).  U.S. residential construction is likely to resume its traditional role as a locomotive driving U.S. economic recovery.  For the first time in almost five years, U.S. housing starts climbed over the one million unit mark in March (1.036 million annualized).

The Agricultural Index also contributed to firmer overall commodity prices last month, rising 0.7% m/m.  The gain was entirely centred in Atlantic Coast lobster prices (the highest value fishery in the Maritimes), with prices skyrocketing as late-winter storms tightened supplies. In contrast, No.1 spot prices for canola (in store Vancouver) eased back seasonally from an all-time record high of US$674 per tonne in February to US$659.  However, tight farm stocks in Canada limited the decline.

The Metal and Mineral Index lost ground in March (-3.7% m/m), with both base and precious metals moving lower.  Gold prices (London PM Fix) eased from US$1,628 per ounce in February to US$1,593 in March and plunged as low as US$1,321 in intra-day trading on April 16, before partially recovering to US$1,471 in late April.  Physical demand for gold (coins and bullion) has picked up - especially in Asia - indicating support for gold at recently lower prices.  The U.S. Mint sold the most gold coins in April since late 2009.

The sharp selloff in gold prices on Friday, April 12, 2013 and Monday, April 15, 2013 (the steepest two-day decline in 30 years) was triggered by news that Cyprus might sell 10 tonnes of gold to raise 400 million euros towards its bailout package.  While 10 tonnes is small compared with world central bank holdings of 31,694.8 tonnes, financial markets were concerned that this might set a precedent for sales by other distressed eurozone countries.  Italy holds 71.3% of its foreign exchange reserves as gold (a significant 2,451.8 tonnes), Portugal 383.5 tonnes and Spain 281.6 tonnes.

In my view, it is unlikely that other eurozone countries will sell gold (under the control of national central banks rather than finance departments).  In any case, under the Central Bank Gold Agreement (CBGA) between European countries or CBGA (effective until September 2014), gold sales will be limited to 400 tonnes annually (the total for all signatories).  A suggestion by two investment banks that investors "short" gold also contributed to the correction from April 12-16, 2013.

Gold prices were already languishing in early 2013, as investors shifted from gold to U.S. equities, anticipating that the U.S. economy would start to pick up in 2013:H2 and that the Fed would not need to apply even more quantitative easing to kick start the U.S. economy.  The January Federal Open Market Committee (FOMC) minutes revealed discussion by some participants over the merits of the Fed's asset purchase program (the monthly purchase of US$45 billion of mortgage-backed securities plus US$40 billion of longer-dated Treasury securities) - a form of quantitative easing.   While the Fed is unlikely to begin withdrawing this program until 2014, the mere discussion of its withdrawal was enough to unnerve some gold investors. In addition, the failure of Basel III to include gold in the liquidity coverage ratio for banks also hurt gold, as did the concern by some mutual funds that world economic risks were shifting from inflation to deflation (we are not of this view).  The gold price forecast for 2013-14 has been moderately revised down.

Brent oil - the international benchmark for light crude oil prices - eased from US$116 per barrel in February to US$109 in March, falling as low as US$97.69 on April 17 in the wake of the mid-April correction in industrial commodity prices.  While snapping back to US$103, prices remain at a lower ebb in late April - likely reflecting subdued world crude demand, amid exceptionally high spring maintenance at refineries across Europe, the U.S. and Asia, and stronger North Sea production in late 2012.  As much as 6.8 million barrels per day (m b/d) of refinery capacity will be offline in April due to spring maintenance, though world petroleum demand should pick up again as second-quarter downtime comes to an end.  Interestingly, the spread between Brent and WTI oil has narrowed from US$20.75 in February to US$9.95 in late April.  While mostly related to a more comfortable supply picture in northern Europe, the recent expansion of the Seaway Pipeline between Cushing, Oklahoma and Texas has also helped.

The recent narrowing of price discounts on WCS heavy oil off WTI reflects three developments, one of which is temporary: 1) a seasonal increase in demand for Western Canada's crude oil, as U.S. Midwest refineries returned from an unusually high level of maintenance downtime in early 2013; 2) operational enhancements allowing greater volumes through the pipeline system, after apportionment by Enbridge at the turn of the year; and 3) the stepped-up use of rail, allowing more Alberta crude to find its way to the higher-value refining market in Texas, where world prices prevail.

While the Seaway Pipeline (Enbridge/Enterprise Partners) from Cushing, Oklahoma to Texas was expanded to a design capacity of 400,000 barrels per day (b/d) in February 2013, actual volumes through the pipeline have been limited to 300,000 b/d - shipping more light than heavy crude oil.  The overall pipeline system from Canada to the U.S. still constrains flows of Western Canada's oil to Texas, where heavy Mayan crude from Mexico (only marginally higher in quality than WCS Heavy) is currently priced at US$96 per barrel - above WTI oil at US$91 - and US$25 above the US$68 garnered by heavy oil producers in Western Canada (subtracting a US$2-3 per barrel quality discount, but not adjusting for transportation costs).  Presidential approval of the Keystone XL Pipeline - connecting Hardisty, Alberta to Steele City, Nebraska - would allow greater volumes of Canadian crude to reach Texas refineries (many of which are configured to handle heavy oil and are thirsty for this feedstock), significantly boosting prices for Alberta and Saskatchewan heavy crude.

However more pipeline capability to tidewater on the West and East Coasts of Canada is also critical to provide the export and market optionality needed to guarantee higher world prices for Canadian light and heavy crudes.  Prices for Saudi Arabian heavy crude delivered to China averaged US$106 in 2013:Q1. Given the low cost of tanker shipping and pipeline transportation, the netback for Alberta sales of heavy crude in China would have been quite high in the first quarter (probably more than US$95) had transportation infrastructure been available.  The cost of tanker shipping from the B.C. Coast to China is only US$3-4 per barrel.

London Metal Exchange (LME) copper prices eased from US$3.66 per pound in February to US$3.48 in March, dropped to a low of US$3.09 on April 23 (oversold) - following news that China's GDP slowed to 7.7% yr/yr in 2013:Q1 - and then rallied back to US$3.20 late month.  Prices remain lucrative, yielding a 34% profit margin over average world breakeven costs including depreciation for mining companies.  Despite financial market jitters, fabricator-demand has been picking up in China, with stronger end-use indicators for air conditioners, power cable and inter-connect markets.  After rising by a mere 1.7% per annum from 2008-12, world 'brownfield' mine expansion finally appears to be getting underway - a development which will probably dampen prices in the next several years.  However recent suggestions that copper prices were about to fall below US$3 are well ahead of market conditions.  We expect copper prices to average US$3.40 per pound in 2013, US$3.20 in 2014 and slightly below US$3 in 2015. Copper is expected to rebound in the second half of this decade, with an end to the current round of copper mine expansion and ongoing demand growth in China and 'emerging markets'.  In 2011 (latest data available), auto ownership in China was a mere 70 per 1,000 people and in India 20 compared with 793 in the U.S. and 588 in Western Europe, pointing to strong metal and gasoline demand going forward.  The Bull Run will return.

Spot potash prices (Freight On Board Vancouver) edged down again from US$410 per tonne in February to US$407.50 in March - below the US$452.50 of last December.  However, prices appear to be at a bottom, with a moderate recovery expected in the second half of 2013.  While this year's price recovery may be limited, shipment volumes should rebound more substantially, as buyers restock after deferring orders last year.  High grain and oilseed prices should also incent farmers to apply more potash fertilizer this spring.  World shipments should jump to 56 million tonnes in 2013 from 51 million last year.

Premium-grade hard coking coal investors also received some good news recently, with the quarterly contract price between the BHP Billiton-Mitsubishi Alliance and Nippon Steel increasing by US$7 to US$172 per tonne (Freight On Board Australia) for 2013:Q2 (April-June).  This points to firmer prices in the second quarter for Western Canada's hard coking coal at Vancouver bound for North Asian markets.

SOURCE: Scotiabank - Economic Reports

Patricia Mohr, Scotiabank Economics, [phone], [email protected]; or
Joe Konecny, Scotiabank Media Communications, [phone], [email protected].