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Can the momentum in the manufacturing sector be sustained, with
prices rising further over the near-term? To be sure, the rise in
prices highlighted by the four-month rally in our Materials Price
Index does indicate the worst of the recession globally is over.
But the continuing increase in COVID-19 case counts globally, and
the re-imposition of containment measures even in regions that had
seemingly beat-back the pandemic, underscores what is likely to be
the start-stop pattern to growth.
Commodity prices have staged an impressive rebound between April
and mid-August. As measured by our Materials Price Index (MPI),
prices have erased their first quarter plunge during the last four
months and are now up 3.4% for the year.
Why the quick recovery? A combination of factors seems to be at
play: the strong performance of the Chinese economy, production
cuts (oil) or supply disruptions (copper), a weaker US dollar, huge
government stimulus and even hope for a vaccine late this year.
Pent-up demand, changes in consumer spending patterns and business
inventory management are also contributing to the rebound in
manufacturing activity, supporting prices.
For consumers, suppressed spending on many activities (travel,
restaurants, entertainment) is channeling purchasing towards goods
(and saving), with much of the pent-up demand from earlier this
year being released now. Businesses have helped boost the apparent
consumption of commodities by replenishing stocks run down during
the first half of the year. Firms also seem to want higher
inventory in their supply chains because of disruptions, a decision
made easier by low financing costs.
In terms of physical consumption, our caution is that the rise
in commodity prices does not foretell a full recovery in 2020 or
even 2021, as the damage to labor markets worldwide has been too
great. Goods markets have benefited - temporarily -- from the
change in behavior. The question is, will consumers embark on a
fresh round of goods purchases with labor markets still weak and
government transfers being dialed back? We think it unlikely.
Likewise, the boost to apparent consumption from inventory
restocking will be difficult to sustain unless firms feel
comfortable with even higher inventory sales ratios, which in some
industries already look elevated, even granting a desire to hold
higher buffer stocks.
In short, we think the rebound in manufacturing is more likely a
bounce (albeit welcomed) that will be difficult to maintain.
Likewise, the run-up in material prices since April has been
impressive. However, do not expect the momentum to carry across the
rest of 2020
Let's take a closer
The rally in commodity prices per our MPI, continued last week
with the index rising 2.0%, its fifteenth increase in the last
sixteen weeks. The slow-down in COVID-19 case count growth in badly
affected countries and hope for targeted stimulus in China helped
lift nine of the MPI's ten components last week in another
broad-based gain.
Energy led the MPI higher last week, rising 3.1%. LNG was again
responsible for most of the increase, jumping 19.1%. Asian LNG
prices rose 24%, European prices 21% and US prices 11%. Strong
demand, tied to hot weather in Japan and North America boosting
electricity generation, and low gas storage levels in Europe, were
behind the price increases. Steel raw materials prices rose 1.9% as
iron ore moved yet another leg higher on China stimulus news. Iron
ore prices have also been supported by a building queue of bulk
vessels at Chinese ports. Lumber shows no sign of slowing down,
with another double-digit rise of 11.5%. Strong single home sales
and housing starts in the US, fuelled by low interest rates,
continue to keep the lumber market off-balance. Non-ferrous prices
rose 2.0%, with copper and nickel rising 2.9% and 3.2%,
respectively. Copper moved higher on falling exchange inventory and
a court ruling in India that will keep that country' largest
smelter closed indefinitely.
Commodity markets chose to brush aside disappointing August
flash Purchasing Manager Index reports and slower growth in Chinese
retail sales last week. Instead markets focused on the slow
relaxation of COVID-19 containment measures worldwide and the
Peoples Bank of China's new 700-billion-yuan credit facility.
Markets are viewing the credit facility as fuel for the spending
authorities have promised for targeted infrastructure investments
and hence bullish for commodities exposed to China, reinforcing the
positive sentiment regarding mainland China already priced in.
Posted 26 August 2020 by John Mothersole, Director – Research, Pricing and Purchasing and