Gold:silver ratio will narrow, but base metals outlook ultra-gloomy – UBS
Investment bank UBS has published its latest economic and commodity forecasts, cutting the prognosis for global GDP growth to 1.3% from 2.2% while suggesting that there are still downside risks to the economic outlook as a result of the speed and magnitude of the deterioration in demand. The bank’s forecasts for commodity prices have been cut "deeply" for 2009 and 2010, in the expectation that the contraction in credit and finance is unlikely to be reversed in the near term, and that its impact on the real economy will continue over the next two years.Key benchmark commodities oil and copper are forecast to average US$60/bbl and US$1.30/lb in 2009. This compares with averages of $72.4/bbl in 2007 and $109.7/bbl in 2008 year-to-date for oil and of $3.35/lb and $3.47/lb for copper. UBS also expects that iron ore will face a 40% price decline for next year’s contracts. With the exclusion of precious metals the bank has cut its commodities estimates by an average of 37% and its latest forecasts for the average prices in 2009 are below the market consensus; in the majority of cases the forecasts for the 2009 average lie at levels below those currently prevailing. The largest downward adjustments are in the case of uranium and copper, closely followed by nickel, zinc and oil.The analysis looks at some of the more important market characteristics for selected commodities, including demand elasticity, supply growth, inventories, industry consolidation and cost pressure (including an interesting exercise on marginal costs and their impact further down the line) and created a "Structural Characteristics" chart that encapsulates the relative outlook across the sectors. Platinum is one of the commodities that fares the best, and while the outlook for the auto industry may keep pressure on the metal in the medium term, the collapse of the platinum-gold premium bodes well for a recovery in the jewellery sector when confidence returns. UBS implies that this gives a better outlook for platinum than for palladium and rhodium as these latter metals have a lower jewellery coefficient in their demand profiles.Gold is expected to remain under pressure in 2009 as a result of slowing jewellery demand in important emerging markets and a continued strengthening in the dollar, while silver forecasts have been sharply reduced. The silver mining sector will show a stronger response than that of gold to price falls (not least because over 70% of silver mine supply comes from gold, copper and lead-zinc operations, with the latter under particular pressure) and this is a driving force behind the bank’s suggestion that the gold:silver ratio will narrow. The ratio currently stands at 75, after an average so far this year of 57 and of 52 in 2007.Base metals prices are expected to "dip meaningfully below marginal costs" next year, following on from the sizeable contraction in demand, combined with destocking from both producers and consumers; exchange inventories are therefore expected to build over the next few months. For the longer term, capacity shutdowns and project deferrals in 2009 will eventually filter through as a price-supportive factor, leading to a modest recovery in 2010 and the likelihood of something more robust in 2011/2012. The study inclines to the view that rather than a rapid reversal, the impact on the real economy of the problems in the credit / financing issue will be a slow, drawn-out process as the excesses of credit over the past twenty years are unwound.This, combined with the reduction in marginal costs applicable to the mining sector, means that long-term price forecasts have also been reduced, with, for example, copper being trimmed to $1.50/lb and aluminium to $1.10/lb (compare prevailing spot prices of $2.04/lb and 92 cents/lb respectively). The study iterates the important point that, while marginal costs analysis is a vital tool for looking at market-clearing levels, marginal cost of itself does not necessarily represent an absolute floor for a particular commodity price. There are circumstances in which prices may lie below marginal costs for a considerable period, forcing an industry to experience considerable financial pain before prices recover. In the current environment the view to the horizon for the base metals industry is not a pleasant one.