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Global Securities Research & Economics GroupMost Agricultural Markets Have Bearish Supply/Demand Structures
(November 17, 2000) As evidenced by the table, energy continues to be the only sector of commodities that shows strength and in fact the rest of the commodity board remains downright weak. Agricultural markets have been particularly negative including all-time low prices in coffee and a 27 year low in cocoa while the grain/soy complex is off 11 percent year-to-date on top of 1999's fall of 24 percent. While the view is that most of these commodities have discounted the worst and have limited additional downside potential, their supply/demand balances are mostly burdensome, and at least at this point, upside potential also seems limited except in a few cases.
Dow Jones-AIG Index--Percent Change
-- Month through Nov 13 Year to date All of 1999 Total Index Up 4 Up 17 Up 19 Energy Up 11 Up 86 Up 79 Petroleum Only Up 6 Up 70 Up 100 Livestock Unch Dn 2 Up 9 Grains Up 2 Dn 11 Dn 24 Industrial Metals Dn 2 Dn 11 Up 26 Precious Metals Dn 1 Dn 14 Dn 3 Softs Dn 4 Dn 7 Dn 27 Source-William O'Neill Sugar has been a rare non-energy bull market and in spite of a 2.5-cent correction from its mid-October high of 11.4 cents per pound, sugar is up about 3 cents for the year and double its 1999 low of 4.36 cents. In our view, the correction was a long overdue technical consolidation and the basic fundamental picture is still seen as positive. A long side bias seems deserved and the correction makes sugar an attractive proposition for hedge users. The fact that the Russian winter buying season is about to commence adds to the positive seasonal picture. In addition, Iraq, Taiwan and Tunisia have issued buying tenders and the overall export market looks buoyant. Non-energy buy recommendations have been a rarity this year but we think sugar represents an exception.
Cotton might represent another market that has upside potential. At worst, the cotton seems to have clearly bottomed and the outlook for the global cotton crop indicates that high quality cotton will be in particularly short supply and that the United States may be the only game in town. While it is premature to anticipate an imminent rush of demand, activity should increase by late winter. Thus the March contract might benefit while December prices meander within their recent trading range. Export sales have been disappointing recently but that could be expected to gradually change. The March/December spread appears to be a good play, particularly with the threat of 270,000 bales of certified stocks keeping the threat of heavy deliveries in focus. In our view, natural hedge buyers should be looking to position March cotton on weakness. The contract is currently sitting just over 65.00 cents but prices in the 75.00- to 80.00-cent range seem a reasonable objective for end first/early second quarter of next year.
Grains, despite being above their lows, continue to trade in a mostly lackluster pattern. The latest production reports from the USDA did show lower U.S. corn and soybean production but that is what the market was looking for and it was fully reflected in the existing price structure. In addition, soybean production levels in Argentina and Brazil were raised although this was also anticipated. The USDA projected a soybean carryout of 350 million bushels, which is burdensome. A carryout of 300 to 310 million might be needed to create even mild enthusiasm. Soyoil ending stocks were particularly bearish at 2.145 billion pounds, the highest level since the 1991-92 season when they were 2.239 billion.
The picture for corn seems more constructive. Ending stocks for 2000-01 were pegged at 1.679 billion bushels by the USDA, down from 1.817 in last month's report and 1.715 last season. Thus some mild optimism might be justified for corn prices.
Over in the metals arena, we remain on a "red flag" price watch for copper but it should be emphasized that this is a "soft landing" type alert. The latest data from the International Copper Study Group illustrates our expressed opinion, shared by our base metals equity colleague Dan Roling, that the long-term prospects for copper are positive. According to the ICSG the world refined copper market, while indicating a 55,000-tonne surplus in August, up from a 3,000-tonne July surplus, the accumulated deficit, repeat deficit, for the first eight months of 2000 was 400,000 tonnes compared to a 122,000 surplus in the same 1999 time frame. A 50,000-tonne drop in European consumption was the main factor in the weak August data. In percentage terms, world refined copper consumption has grown by 7.6 percent in 2000 while production is up a mere 2.6 percent. These numbers are clearly not bearish and we continue to see copper prices rebounding next year, probably in late first/early second quarter. Shorter term, however, copper prices should remain defensive and we have lowered the bottom from short- to intermediate-term range to 79.00 cents from 81.00 cents.
Energy prices remain high with tightness in heating oil and natural gas stocks featured. Recent studies indicate that the average household will be paying $250 to $300 more for heating costs this winter. Despite this, numerous Federal Reserve officials have downplayed the impact of skyrocketing oil prices on the economy. Typical is a recent comment from Federal Bank of Philadelphia President Anthony Santomero, who said, "high energy prices have thus far not weakened the broad U.S. economy." He said the Fed was monitoring the situation but noted "it is comforting that United States has grown much less dependent on oil, lessening the risk posed for the U.S. economy by soaring oil prices." While we would not disagree with his premise that the U.S. has grown less dependent, we do think the cost of energy has impacted global growth and could potentially hurt the retail sector and by extension demand for some commodities. As we conclude this comment December heating oil is trading $1.05 per gallon while natural gas is at an all-time high of $6.02 per million btu and the top does not seem to be established. The weather forecasts are ominous.
(Reprinted by permission. Copyright 2000 Merrill Lynch, Pierce, Fenner & Smith Incorporated.)
November 17, 2000 William O'Neill Merrill Lynch & Company Global Securities Research & Economics Group North Tower, 21st Floor World Financial Center, New York, New York 212-449-1854
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