Commodities are bearing the brunt of the trade war between the U.S. and China as prices have dropped to the lowest level in five months. Bart Melek, Head of Global Commodity Strategy, TD Securities, talks to Kim Parlee about where prices are headed, which commodities are under pressure and which are bucking the trend.
Commodity prices are one of the first victims of an intensifying trade dispute between the United States and pretty much everyone, including China. The Bloomberg Commodities Index, which is a compilation of 26 different commodities, is showing a bit of a hit and some of the biggest drops we've seen in five months. Here to give us some perspective on why this is happening-- and will this continue to happen-- is Bart Melek. He's Head of Global Commodity Strategy at TD Securities. Bart, let's start with, did the commodity markets see something that the equity markets are not seeing right now?
Well, I think the commodity markets, by definition, are a little bit more sensitive to what's happening in China. The main reason, of course, is that about half of every metal consumed globally is consumed in that country. China is the biggest incremental new consumer for energy.
So any time there is any sort of doubt about the Chinese economic performance and potential demand, it weighs quite heavily on what we project for supply/demand balances to be for pretty much every major commodity that we trade.
And I guess, of course, when you have trade skirmishes-- which, they do blow up into full-blown trade wars-- that has a real impact on demand. And then of course, in a little while, it could actually affect supply at the same time.
Absolutely. What we're worried about now is that the current aggressive talk from the White House will actually translate into a full-blown trade war between the United States. And in fact, we could envision a situation where America's NAFTA partners are also being tariffed to death, so to speak. And that would have an impact of increasing aggregate prices all around, reducing trade flows. And in the end, that would result in less aggregate demand globally.
This means that certain commodities, like zinc, for example, that we have expected to tighten up could actually not tighten up at all. And we could get a surplus, particularly since there has been a response on the supply side to the higher prices we've seen. The same thing can be said about crude, for example.
I wouldn't mind focusing in on zinc. Because we've got a list here to kind of say, who's reacting to what? But zinc is one of the ones you are seeing where there is a more profound reaction than the other commodities.
Yes, we are. Zinc has dropped over 30% from its peak. And the big reason here is not that there's anything particularly wrong with the zinc market, but it was the one that-- there was a broad consensus-- that we were thinking that it was going to be quite tight. Demand was robust. Supply was constrained, and prices were quite high.
And therefore, that generated some supply response where previously shuttered mines were reopened. And now we have a problem with potential demand going forward. So the folks that were very, very bullish, that took very aggressive long bets, all of the sudden unwound those long positions, and maybe took on some shorts. And that basically means there was no momentum anymore. And the technicians took over and really beat the metal up, so to speak.
What about crude? I mean, there's so much going on with crude. I mean, you've got the Iran sanctions. I know there's been some big drawdowns lately, which didn't really seem to affect the price in an upward way. What would you say is that is the trade impact on crude right now?
Well, the trade impact on crude is not as large as some other commodities. But there has been a demand concern. The worry is, again, if we see a broader trade war develop that is sustained over a period of time, this will impact economic growth. And this would imply that demand may be less robust than we thought.
So as opposed to having 1.4 million barrels of demand growth over the next two years or so, we could have something less. And at the same time, OPEC has been pressured by the United States to increase supply to compensate for the large inventory draws we're seeing and also to compensate for the potential losses from Iran due to the sanctions. And then what we've seen is Saudi Arabia also, tell us that they are deploying more cargoes of crude globally. You combine that with some demand worries and a high US dollar, and traders, I think, decided to take profits and remove some of the extremely long positions they had.
Yeah, there's a lot of moving parts with crude. What about copper, Doctor Copper? I mean, is that a canary in the coal mine? Or are we seeing more reaction in zinc than we are in copper?
Well, copper is one that is rumored to foretell what the global economy is about to do. And copper's telling us at this stage that demand may not materialize to the same extent as we thought. At this point, we're not really seeing material declines in demand.
In fact, across many sectors, there is a bit of a surge in production to maybe get ahead of any potential tariffs. So demand is quite robust. But the concern is going to be that, six months down the road if this problem continues on the trade side, we will see less copper demand.
Let's remember, China consumes some 50% of all copper and accounts for a great deal of new demand growth. And it exports a lot of the material that it produces to the rest of the world. If we see less demand, not only domestically in China but in other parts of the world-- for example, air conditioners to the United States, should they be targeted-- that means less copper will be needed to make those products.
Prices would go up. And demand would likely go down. And the market was thought to be in the balance moving towards a tight environment pending some potential strikes in Chile. And now that is off the table.
Clearance and some global warming on those air conditioners is a whole different conversation. Gold, what's happening with gold? I mean, the US dollar obviously has been strengthening. That tends not to be good for gold. But what else is happening there?
Well, gold is reacting to, first of all, the US dollar. The higher the US dollar tends to be, the worse gold tends to perform. But when you look at the dollar relationship to the Chinese currency, the Chinese currency has been depreciating quite robustly lately. And there is a very strong relationship between gold prices and the Chinese currency.
As the Chinese currency weakens, the dollar seems to weaken, as well. And we are seeing evidence in the physical market that there is less demand for the metal within China. And Indeed, the emerging market risk-off environment hasn't been very good for gold.
We are seeing potential problems for some highly-indebted countries who owe US dollars to the rest of the world to pay their debt, perhaps swapping, or borrowing the metals, selling it on the market, and getting dollars that way to increase liquidity. So there may be some of that going on. And of course, there is the US Fed, which has been, for the last little while, somewhat hawkish, one could argue. And certainly, the dots are telling us that there could be a prolonged period well into 2019 of hikes.
Let me ask you-- only about 30 seconds-- from a trade perspective, is there anything that you're going to be listening to or your folks are going to be listening to you in terms of, like, yeah, OK, this is accelerating in the wrong direction, and we're going to see a bigger reaction in commodities?
Well, I think, if China reacts with a tit-for-tat set of measures against the US and goes beyond the current imports-- for example, if it starts hitting services, if it starts using non-tariff barriers, regulations, and others, if there is a general escalation-- and I would also be watching for any impact on jobs in the United States. If there is no impact on jobs in America, then there is really very little political incentive for the current administration to take the pressure off. I think you will see problems. So I suspect much of this will be resolved prior to the November vote.
Thank you, Bart.
My pleasure. Thank you very much.