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By Clyde Russell
SINGAPORE, April 12 (Reuters) - - It would be easy to dismiss the assertion by BHP Billiton Chief Executive Andrew Mackenzie that commodity prices have bottomed as the wishful thinking of a mining executive keen to see some improvement in profit margins.
While it’s likely that the boss of the world’s biggest mining company is hoping for an end to five years of a declining price trend for many of the commodities his company produces, there is enough price evidence to suggest he may be right.
It’s probably a little too early to call for a rebound in commodity prices, and Mackenzie was suitably cautious in his comments published last weekend in The Australian newspaper.
But the fact that it is now possible to construct a narrative, with supporting price data, for even a mild recovery in commodities is something of a sea change.
For at least the past two years it has been virtually unrelenting doom and gloom in the sector, with any price rallies proving to be false dawns as the industry battled oversupply as well as slowing demand growth in top consumer China.
The oversupply was a problem the industry created for itself, having believed the hype that commodity demand and prices would rise for decades on Chinese demand, with supporting roles from India and other developing Asian nations.
The slowing demand growth in China was always inevitable, but it arrived sooner than virtually anybody expected, and given Beijing’s efforts to move to a more consumer-led economy, it’s not likely that China’s appetite for commodities will re-accelerate any time soon.
So why is the boss of BHP expressing some optimism that the outlook for commodities is improving?
“If you look at the basket of commodities that we deal with, the numbers are self-evident: the fall has stopped,” Mackenzie was quoted as saying in the interview published on April 9.
Spot iron ore in Asia .IO62-CNI=SI is up 30 percent to $55.90 a tonne so far in 2016, Brent has gained almost 15 percent, London copper is almost flat as is Newcastle coal, while coking coal has risen about 14 percent.
These four commodities represent the bulk of BHP’s portfolio and while prices look weak compared to where they were five years ago, Mackenzie is right insofar as they have stopped declining so far in 2016.
This certainly gives cause for some optimism that prices have arrested their declining trend, and while a sustained rally may be a tad hopeful, a period of bouncing along the bottom with little rallies and pullbacks is a reasonable expectation.
But what will it take for confidence to come back that commodity prices have actually bottomed?
It will take supply discipline and demand growth, or at least one of them.
Looking at BHP’s major commodity products, it’s not evident that supply discipline and demand growth are present in any meaningful way.
Iron ore is BHP’s top earner, and here the major producers, including the top two Vale and Rio Tinto still have plans to increase output.
Supply discipline is only coming from higher cost mines being forced to close, but it’s still questionable as whether enough of these operations are being idled to offset likely additions.
Seaborne iron ore volumes may actually rise, but only if more domestic Chinese output is shut down, meaning that the demand side of the equation is extremely price sensitive.
The major miners can have rising volumes, but only at the expense of low prices.
In copper, again supply discipline is lacking, with new operations expected to add to global ore volumes this year.
Demand is also somewhat cloudy, with uncertainty over whether China’s appetite for imports can be maintained and market participants raising the possibility that China may actually export refined copper given weak industrial demand at home and substantial inventories.
Coal is probably further down the road of supply discipline than other commodities, with formally major exporters like the United States having virtually exited the seaborne market, and lower volumes coming out of Indonesia and Australia.
But this supply reduction is being matched by demand concerns, with the world’s top two importers, China and India, buying less of the fuel in what may prove to be a structural shift lower.
Crude oil is also battling its supply issues, with top producers meeting this weekend in Qatar in an effort to agree some kind of output freeze.
Similar to other commodities, it’s far from certain that these efforts will actually work, meaning that crude is unlikely to experience much of a supply-led rally.
Oil demand is somewhat more constructive, but even here it’s likely that it will take months, if not years, for demand growth to catch up to available supply.
Overall, it seems that there are some reasons to be a little confident that commodity prices are set to stabilise, but the conditions for rising prices are still not fully apparent. (Editing by Himani Sarkar)