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Market Bulletin - Commodity slide

16 November 2015

The tragic events in Paris put into sharp perspective the continuing decline in commodity prices.

At the time of writing, after falling in early trading, France’s CAC 40 index was showing the resilience and resolve that can be the only response to the horrific attacks by terrorists in Paris on Friday night. The tragedy made even more insignificant other events in a week which, with the exception of the Nikkei 225, was a bad one for markets.

Worries about US consumer demand, a profits warning from Rolls-Royce and poor corporate earnings in Europe didn’t help, but it was commodities that dominated. It now seems the major metals were yet to reach their price floor, as last week they reached multi-year lows.

Zinc, used to galvanise iron ore and steel, fell to its lowest price in six years, while copper dipped below $5,000 a tonne for the first time since the global financial crisis. China accounts for around 45% of global copper production.

The steel situation is more worrying still, as China accounts for half of global production and buys two thirds of the world’s iron ore – the chief input for steel mills. The price for Australian iron ore – Australia is the world’s major producer – has dropped by 15% in the past month. The price of iron ore has now fallen 75% from its 2011 peak. Market idiosyncrasies aside, the commodities outlook relies most fundamentally on Chinese demand; but the Shanghai Composite Index dropped 1.4% over the course of the week, reflecting commodities fears, and official data released in China last week sounded mostly gloomy notes.

Consumer price growth was down significantly from September levels while investment expansion hit its lowest levels since 2000. China’s industrial production growth rate continued its decline, falling a little further in October to 5.6%. But it was neatly balanced out by an equivalent rise in retail sales growth. This was 11.0% in October, with car sales providing a highlight. The improvement didn’t seem to help Burberry, a company whose retail success is heavily reliant on China, as it announced half-yearly results that showed revenue flat and profits effectively zero (once currency conversion is allowed for).

“From our visits to the country, the slowdown in China has been evident for two to three years. It puzzles me why the markets are still surprised by what we’re seeing,” said Stuart Mitchell of S. W. Mitchell Capital. “For luxury goods we are still hearing growth projections of 15% year-on-year for China and 10% for Russia, which in my view are simply fanciful.”

Few indices suffer more heavily from energy and mining downturns than the FTSE 100, which posted a one-week decline of 3.71%. Oil’s sharp fall to just $43.65 a barrel – representing an 8% drop over the course of the week and its lowest price since August – impacted key energy stocks such as Shell and BP. Shell saw almost 6% shaved off its price over the course of the week, while BP lost almost 5%.

Neither loss could hold a candle to Rolls-Royce, which lost a quarter of its value following the company’s fifth profit warning in 20 months. The company said it expected an earnings decline of £650 million in 2016, and the chief executive promised to reduce the company’s costs by up to £200 million from 2017 – this is on top of the £115 million in cuts already committed to across the company’s auto, marine and aerospace operations.

The UK saw far more encouraging news in the real economy, as unemployment fell to its lowest level since April 2008, dipping by 103,000 in just three months, but UK earnings growth was more disappointing. In company results, half-year profits at Sainsbury’s fell almost 20%, but Vodafone revenues were up 1%, above expectations and boosted by strong revenues from Africa, Asia Pacific and the Middle East.

Meanwhile, the UK government agreed the sale of £13 billion in Northern Rock mortgages to a private equity company. Northern Rock was one of the UK’s headline casualties during the global financial crisis.

Federal resolve

Wall Street fell barely less than the FTSE last week, losing 3.13% in its first weekly fall since September. Weak data for retail sales and producer prices raised concerns about domestic demand, even though the consumer sentiment gauge was up marginally, according to an index published by Reuters and the University of Michigan.

Low oil and commodities prices contributed to expectations that inflation would remain subdued. Federal Reserve official Charles Evans acknowledged last week that US growth is strong and that the Fed is close to its employment target – a key variable in any Fed decision to raise interest rates – but also said that inflation may fail to reach its 2% target. His colleague, William Dudley, pointed to the decline in unemployment and the rate of economic growth, before adding, “It is quite possible that the conditions the Committee has established to begin to normalise monetary policy could soon be satisfied.”

Markets took the various committee member comments as tipping the balance still further towards a December rate hike. As the dollar rose, the yield on ten-year Treasuries fell slightly to 2.28%.

Tokyo flows

In a week of selling on major markets, investors on Japan’s Nikkei 225 appeared to be in a very different mood, taking stocks to a 12-week high. The index rose 1.72% over the course of the week. In part it was enjoying the continued bounce from a successful listing of Japan Post, although by Friday this has tailed off, and there were growing numbers of voices arguing the government had sold the stock too cheaply.

The midweek stock rise was also down in part to hopes that the Bank of Japan would introduce further monetary easing policies in the coming weeks. There was some macroeconomic encouragement last week in the form of improved core machinery orders (up 7.5%), but this was overshadowed by today’s release of its third-quarter GDP figures. The Japanese economy contracted by 0.8% over the three-month period, a larger drop than feared. Japan is now in technical recession, which makes quantitative easing all the more likely.

Europe easing

Stocks in Europe suffered headwinds from poor corporate earnings and concerns over commodity prices. The FTSEurofirst 300 fell 2.74%. Some companies, Swiss biotech company Syngenta among them, announced positive results, but more than half the companies on the STOXX Europe 600 (an index of major companies) fell short of market expectations.

Eurozone GDP slowed to just 0.3% over the third quarter. Germany and France moved at the same rate – disappointing for the former but good news for France. Greece looks to be returning to recession. Last week Mario Draghi, president of the European Central Bank, told the European Parliament the bank will look at fiscal stimulus again in December. He added that “the option of doing nothing would go against price stability”.

Amid the limp indicators, it is worth remembering that corporate earnings results rarely reflect the status quo.

“The European recovery is still too early to yet come through in earnings,” says Stuart Mitchell. “France has seen a 30–40% increase in building permits this year. In southern Spain, you can at last sell your house, albeit not necessarily for the price you’d like. Europe will be growing faster than US by the end of next year, but it always takes a long time for the investment community to look somewhere else,” says Mitchell.


S. W. Mitchell Capital is a fund manager for St. James’s Place.

The information contained is correct as at the date of the article. The information contained does not constitute investment advice and is not intended to state, indicate or imply that current or past results are indicative of future results or expectations. Where the opinions of third parties are offered, these may not necessarily reflect those of St. James’s Place.

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