Even though the country is still officially in recession, Finance Minister Jim Flaherty agreed today the economy is “showing some good signs.” Those good signs are reflected mostly in the bullish sentiment returning to the commodities market with base metals and crude oil lifting off lows reached in December.
Patricia Mohr, vice-president, economics, and commodity market specialist at Scotiabank, calls it “genuine improvement; not just improved sentiment.”
Why is that important?
Because traditionally, commodities — especially copper — have been one of the earliest indicators of the direction the economy is headed. So much so, the reddish metal is sometimes hailed as “Dr. Copper.”
This recession, however, has set some new trends.
“This time improvement in the commodities market has reflected an improvement in the equity market, rather than the other way round,” Mohr says.
And more importantly, the balance of economic power has shifted eastward.
“China is now a much bigger market for base metals than the USA, and is driving commodities in a way it didn’t during the previous downturns,” Mohr notes.
Peter Buchanan, senior economist at CIBC World Markets, agrees the rebound in the global economy and commodities will be led this time by the far east countries, especially China, which are also metal-intensive economies.
Sure enough, China’s massive stimulus spending plan is the single largest driving force behind rising demand for copper, boosting international and domestic prices.
China’s State Reserves Bureau is thought to be active in the market, rebuilding the country’s strategic stockpiles. Copper inventories in Shanghai’s warehouses are at their lowest levels for a decade. Copper fabricators have been buying copper and rebuilding inventories, suggesting end-user demand may also be on the mend.
Mohr agrees China’s industrial activity picked up at record levels in March. Now it’s massive infrastructure spending is beginning to impact global economic activity as well.
“Decline in the greenback has also played a role, and no solid bounce-back is expected this year or next,” Buchanan says.
The rally in commodities, Buchanan adds, will translate into sustained benefit for Canada, where 50% of the TSX weight is in resources. “TSX has come a long way. We’ll now see a period of consolidation, until market developments catch up with larger gains in stocks.”
Mohr calls the rally a two-edged trade for Canada. Rising commodity prices have pushed the loonie higher, “and that’s not a positive development for manufacturers.”
According to Patricia Croft, chief economist at RBC Global Asset Management, “The rally is a positive story for Canada. The recession was not made in Canada, and the resolution must come from outside too.”
She says Canada needs a G2 solution — a recovery led by China, and followed closely by the U.S.
The good news for Canada’s resource sector doesn’t just end with copper. The world’s most important commodity, oil — spurred by renewed consumer optimism — is also hot on copper’s heels. OPEC recorded a production increase for the first time in April in nine months.
Croft says both copper and oil rallying together — one reinforcing the other — is an important indicator of recovery.
Traditionally, metals are the first to recover; oil has a one-year lag, according to Buchanan.
Once again China has stolen the lead from the United States in being the driver of demand.
Oil prices have also gained some support from developments in Nigeria, where rebels destroyed major pipelines in the country’s oil-rich southern delta region over the weekend.
The overall global weakness in demand, however, remains a negative for oil, Buchanan says, “The OPEC capacity overhang — seven million barrels — is massive. Even after consumption, there will be about 5 million excess capacity, which is about a couple of years of supply.”
The Organization of Petroleum Exporting Countries will meet on May 28 in Vienna to discuss a possible production cut that would add to 4.2 million barrels a day of output reductions. However, OPEC leaders have expressed they want the price of crude at $70 a barrel this year, and both Mohr and Buchanan say the recent jump to above $60 from below $35 in March will keep the group from any further production cuts.
Mohr adds that while the bullish sentiment in commodities has enhanced prices for resource producers in Canada, there still isn’t much improvement for shipment volumes, and none is expected until next year. She also predicts base metals could fall during the coming months because traditionally demand ebbs in China over summer, and in the G7 due to the holiday shutdown. “There’ll be pickup in fall again.”
(05/25/09)