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Conclusion: Supply constraints could drive many commodities higher, even if growth slows in 2011.


Positions: Long Oil via the etf OIL; Long Sugar via the etf SGG


We’ve been fairly vocal with our belief that global growth will slow sequentially in 2011, driven by the consumer slowing in the U.S., and emerging markets (China, Brazil, and the like) slowing due to monetary tightening as inflation rises.  Perversely (as some would suggest), we remain bullish and, in fact, long in the Virtual Portfolio certain commodities heading into 2011.  Normally, one would expect commodity prices to decline in line with slowing growth, but the key factor appears to be supply constraints for a number of key commodities.

Copper – According to the International Copper Study Group, world refined copper consumption exceeded supply by 436,000 tons between January and September this year.  In the same period last year, the world deficit was 56,000 tons.   In 2010, global consumption was the key factor, as it was up roughly 8%, while mine production was up a measly 0.8%.  The net results of this, as is highlighted in the chart below, is that LME copper inventories have seen a dramatic decline since the start of 2010.  So even if copper usage slows sequentially, low inventories combined with weak supply growth will likely continue to constrain the market and lead to higher copper prices heading into 2011.

If Global Growth Slows, Could Commodities Still Charge Higher? - 1

Oil – Oil is in a similar setup to copper heading into 2011: while the rate of demand growth should slow if global growth slows, oil appears to be supply constrained.  As our Energy Sector Head Lou Gagliardi notes:

“Turning to the Department of Energy, its energy agency (EIA) sees global crude oil demand growth outstripping supply in 2011: by roughly 630,000 b/d or supply falling short by ~0.7%. Although a slim margin, 2011’s forecast marks a sharp divergence from 2009 and 2010, when the EIA reported demand and supply in balance.  For 2011, the EIA, forecasts -0.5% supply/production decline from non-OPEC regions, unlike the 2.1% increase seen in 2010 from 2009.  Not surprising to us, the EIA sees declining supply in 2011 from 2010 worldwide across major crude basins; i.e. the U.S., U.K., Norway, Mexico, Russia, China, and Canada flat.”

The International Energy Administration echoes the point relating to non-OPEC production growth as they have cut in half from 2010 levels their 2011 production estimates, which will be primarily driven by declines form production in the Gulf of Mexico in the United States.  While the OPEC cartel still has spare capacity, to the extent they can keep their members in line, oil supply should be increasingly constrained in 2011.  The negative wild card for global supply could be if Russian production, which recently hit a new high, starts to slow.

Soft commodities – Soft commodities had one of their best years in recent memory in 2010 due to supply constraints and that looks poised to continue headed into 2010.  Some key soft commodity supply data points to focus on heading into 2011 include:

  • Sugar – Brazil, overwhelmingly the world’s largest producer at 23.7% of global production, saw its production estimate for 2010/11 revised down (-1.3M) metric tons to 39.4M due to dry weather;
  • Corn – The Argentine corn crop is developing slower than expected and Argentina is the world’s second largest exporter of corn;
  • Cotton – World cotton stocks are projected to decline in 2011 due to lower U.S. production;
  • Soybeans – Argentina’s soybean production is expected to fall as much as 17% to 43 million tons  in 2011 – 2012 due to the drought caused by La Nina;
  • Rice – Among other supply issues, an outbreak of cholera in Haiti’s rice fields will impact global supply heading into 2011.

Interestingly, despite our view of slowing growth into 2011, it seems that we are seeing evidence of supply constraints across the commodity complex that are poised to drive commodity prices higher in the face of a sequential slowdown in growth.  Higher commodity prices and slower growth mean one thing: stagflation.

Daryl G. Jones

Managing Director