Metals losing lustre under trade clouds
July 4, 2018 • Australian Financial Review

A downturn in commodity prices since the middle of June has split fund managers on whether metals will continue to slide on fears about the health of the Chinese economy and trade wars, or if supply trends will help trigger a price recovery.

Since June 7 copper prices are down 11 per cent, platinum is down almost 10 per cent, nickel is down 6.7 per cent and gold has fallen 4.4 per cent. Oil is the outlier, with Brent crude managing a 0.7 per cent gain.

"People are nervous and locating money away from resources, especially as resource companies have been running hard," said Stephane Andre, portfolio manager at Alphinity Investment Management.

He said he's reducing his commodity-sector holdings against that backdrop.

Those holdings include the majors Rio TInto and BHP Billiton, which are stocks that Mr Andre owns due to expectations of continued capital management. Alphinity also owns BlueScope Steel.

During the past financial year the ASX200 energy sector surged more than 36 per cent while the materials sector of the benchmark of top companies jumped almost 24 per cent.

Mr Andre said investors have turned more cautious on the commodities sector as they fret that the outlook for the Chinese economy has deteriorated after the release of softer purchasing managers index data for June and after the lowering of the reserve requirement ratio for Chinese banks. But "the more important aspect is the fear of a trade war".

Worries about the trading relationship between the US and China have been rising in the past couple of months along with increasingly aggressive rhetoric between the two most powerful economies in the world.

Those tensions racheted up another notch last month when US President Donald Trump threatened additional tariffs against Beijing. China is set to levy tariffs on $US34 billion ($46 billion) of American goods on Friday, the same day that Mr Trump plans to tax an additional $US34 billion of Chinese items.

Copper has shown some of the largest losses in the recent commodities sell-off because the metal tends to reflect broad sentiment towards global trade, according to Mr Andre.

When copper and metals that are sensitive to the economic outlook due to their industrial uses decline, gold can be a beneficiary.

But gold has weakened since the middle of June along with other metals. That price decline is puzzling, Mr Andre said, particularly given expectations of rising inflation.

Bank of America Merrill Lynch offered one explanation, with the strategists pinning the moves in the gold price to corresponding moves in the US dollar. "We believe a weaker US dollar had taken gold higher in the past 1½ years, but the recent rally of the US currency has pushed the yellow metal below intra-year highs" of around $US1300 an ounce, the strategists commented.

Jeremy Bond at Terra Capital remains bullish on the broader commodity markets overall, and positive on nickel and copper trends in particular, saying "the broader story in commodity markets is a supply one".

During the last deep bear market that started in the early part of the decade, supply was taken out of the commodity markets, he noted. If companies aren't producing enough to satisfy demand, then that can push prices up.

At the same time, acquisition-shy majors remain committed to using their cash to pay shareholders rather than expanding supply, the fund manager noted.

In addition, the recovery in commodity markets has also broadened out as investors became more positive, he said, rather than following a single theme as in previous years. For example, a couple of years ago investors were keen on gold stocks, then the sector in favour was nickel.

"This time we are seeing a more broad-based recovery," he said. He pointed to gains in the oil price since the start of 2018, strong copper margins and elevated prices for bulk commodities such as iron ore and coal as reasons to be positive on the commodities sector as a whole.

Mr Bond acknowledged that trade war worries have had an impact on the sector but believes those worries are confined to sentiment and are not yet working on supply-and-demand trends.

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