This article appeared in the January 2012 ASX Investor Update email newsletter. To subscribe to this newsletter please register with the MyASX section or visit the About MyASX page for past editions and more details.
Resource stocks are still the place to be this year.
By David Lennox, Fat Prophets
Fat Prophets has identified five broad themes that will be the primary drivers of commodity prices through 2012. They are a sustained growth in global industrial production, growth in global exports, the European debt crisis, the China story, and the US dollar. Certain commodities may also benefit from the emergence of lower supply.
Overall, we have a positive outlook for commodities in 2012. Prices are likely to move higher as economic activity improves and the US dollar remains in a weak trend. The headwinds confronting commodity prices are potentially extreme, none more so than European debt and the US dollar.
However, sustained growth in global industrial production will be a key factor in determining the direction of commodity prices, and the resilience in this growth to date has been quite remarkable (see Figure 1 below).
Figure 1: Industrial Production Index (2007 = 100).
Source: Netherlands Bureau for Economic Policy Analysis
The global resources boom is driving this. The increased wealth the boom is creating in participating nations and sections of their populations is stimulating the export of goods into these nations.
Through 2012 we expect industrial production growth to remain robust (Figure 2 below). In the early part of the year we forecast growth to be relatively flat, but importantly will remain positive. Toward the end of 2012 we expect the momentum in industrial production to accelerate and the year to close on a strong note.
Figure 2: Global industrial production (quarter-on-quarter annual growth)
Source: Fat Prophets
Our forecast industrial production figures are driven by the ongoing global resources boom and the US economy: the wealth effect of the boom on emerging nations and the appearance of tangible indicators suggesting an economic recovery may be under way in the US. Tentative signs of a recovery in US employment toward the end of 2011, in our view, may lead to a broader improvement in other internal economic conditions.
'No hard landing' in China
The continuation of the resources boom and the re-emergence of the US economy should generate increased demand for commodities and is likely have a positive influence on prices.
The China story will continue to play a major part in determining the direction of commodity prices. The key factor we see for China will be the "no hard economic landing" scenario being played out. Although slowing, the Chinese economy will maintain a pace of growth that will continue to generate an appetite for commodities.
From the latest available data, in 2010 China imported US$1396 billion worth of goods, of which about US$350 billion was commodity focused. We expect the figures for 2011 and 2012 to be only marginally lower than that, which bodes well for commodity prices.
The Chinese authorities have rolled into 2012 with interest-rate settings that are now congenial to stimulating economic growth within that country.
Global exports, although slowing in 2011, have remained remarkably resilient despite the European debt crisis.
We expect global trade in goods and services will continue to slow in 2012 but, importantly, to remain in positive territory. This growth will continue to put pressure on commodity supply chains to deliver.
Looking to 2013, we expect exports to expand as global economic activity improves. From a robust base of 2012 and an expanding 2013, the view of commodity traders is that there is likely to be support for higher commodity prices.
Europe can't be overlooked
From the factors examined briefly, there is evidence the headwinds created by the EU debt crisis may be abating and the global economy is perhaps tentatively moving forward. Nevertheless, to ignore the crisis is perilous, as the well-publicised events that have enveloped the EU have not shown any real signs of repair.
Our view of the EU debt crisis in 2012 is that the framework and policies will be implemented to allow repairs to sovereign balance sheets to begin. Such greater clarity and tangible repair work may start to lessen the risk in the situation and allow small steps forward in confidence, and start to minimise the volatility in market reaction, including for commodities, to negative news.
Importantly, even though EU sovereignty is currently in a calamitous state, it appears many parts of the European private sector are coping with the procrastinations of their political masters. This robustness has the potential to deflect an EU recession. And greater sovereign stability in the EU and a receding fear of a recession would be very supportive of higher commodity prices.
Then there's the headwind facing commodity prices from a potential rise in the US dollar. A number of factors in this article would suggest the trend of a weak US dollar could be over. Recent movement in the US Dollar Index against other currencies tends to indicate the same.
In 2012 we would expect to see a return of capital into the EU as the debt situation and economic certainty in the region improves.
Apart from capital flows, other factors affecting the US dollar are the nation's level of debt and budgetary impasse. The debt position has not been clearly rectified by agreed policy action and may therefore weigh on the dollar sentiment. We expect the dollar to remain weak in 2012 as a result of this uncertainty, and such weakness bodes well for commodity pricing.
Finally, we see certain metals having the potential to move into a supply-constrained market environment in 2012, copper being the prominent one. The constraint is linked to the mining of lower-grade ore and the depletion of mines. In the meantime, demand is expected to remain robust, so we expect to see stocks of copper fall and the price rise.
Exposure to copper is one of our preferred positions for 2012. Other commodities that have the potential to move into supply constraint are zinc in 2013 and LNG in 2014-15.
About the author
David Lennox has been researching Australian equities for over 30 years, with a focus on the resources sector. David's experience includes equity researching for Australian Fund Managers, online Broking and Wealth Management firms. David has been Fat Prophets Resource Analysts for 16 months. Visit Fat Prophets.
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