MPI faces headwinds amid Brexit storm

July 01, 2016 - Weekly Pricing Pulse

Upcoming market headwinds will likely put some pressure on commodity prices; holding off on purchases may be prudent.

Global markets were left stunned on Friday by the United Kingdom's vote to leave the European Union ("Brexit"), especially because as late as Thursday it was expected "Remain" would win. A global asset and foreign exchange rout followed, with sterling in particular recording double-digit declines versus the US dollar. Despite this, the MPI actually ended the week up, rising 0.3% because of a relief rally before the vote. Gains were widespread: oil rose 1.8%, nonferrous metals rose 1.3%, and there were increases in rubber (up 5.7%), pulp (up 1.7%), freight (up 1.8%), and DRAMs (up 1.4%).

Commodity markets did indeed respond to the prospect of a stronger dollar together with fresh demand-side risk coming out of Europe. Crude prices again sank below $50/barrel on Friday, while metals prices dipped by around 2–3%. Early this week we are seeing the global bear market continuing, with UK and core European bond yields falling, gold prices breaking above $1,320/ounce, and major global equity indices experiencing sizable declines. The dollar is also rallying, which puts further pressure on commodity prices going forward.

We expect the MPI to struggle in the coming weeks as the geopolitical and economic shock of the UK decision ripples through. Moreover, the uncertainty could last for months, given the lack of clarity on the future relationship between the United Kingdom and the European Union. Uncertainty has also been created regarding the outlook for the broader EU economy and, in turn, its important trading partners. For commodity markets, this leads back to China, where questions remain about the sustainability of the recent rise in manufacturing activity.

Commodity prices have risen a collective 26% since their January low. It is quite possible that they could give up all of these gains during the next few months. However, we do not expect to see the kind of sustained 63% plunge in prices that took place between the start of 2014 and January 2016 for two interrelated reasons. First, prices are close to production costs in many industries. Second, we are seeing a supply-side reaction to lower prices that is starting to move markets toward balance. Both factors argue for a more "limited" response. Turbulence in markets recommends a buy-as-needed strategy in the third quarter with an eye toward bargain hunting late this year as conditions stabilize.

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