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COMMODITY MARKET TRENDS
Prepared by Merrill Lynch & Co.
Global Securities Research & Economics Group
Strategy Focus
Asian Meltdown Weighs On Commodity Prices
In recent commentaries we have been focusing on the Asian crisis and its impact on commodities, particularly from a demand perspective. We remain convinced that the Asian meltdown will be a depressant for prices well into 1998. Recent activity, as reflected in the various indices, has seen commodities as a whole under pressure as the various Asian currency and stock market declines have served to blunt rallies. Whether it be Japan, Korea, Taiwan, China or one of the Asian Tigers, currency declines and slowing economic growth serve to lower commodity demand potential from the region. The yen is at a five-year low versus the dollar and Japan has just suffered its biggest business failure in memory with the demise of Yamaici Securities. The recent plunge in Korean stock prices adds to the negative mix that permeates this part of the world. South Korea has the world's eleventh largest economy so this is no small matter. A slowing demand from Asia will clearly have impact on GDP growth in the U.S., Europe and South America and markets such as base metals, energy, cotton, grains and even livestock will all feel the pinch. The CRB Index is currently at 235.80 which is down 11-full points since early October. The energy dominated GSCI has recently joined the parade and has dropped from 212.13 on October 7 to its current 190.50. And the industrially oriented Journal of Commerce Index now stands at 240.60 versus 247.60 in mid-October. We would expect all three of these indicators to remain under pressure into the first quarter of 1998. In the past, it has been emphasized that there are virtually no inflationary implications in commodities but there has not really been a deflationary impact either. However, we may be moving into a period where commodities do have at least some moderate deflationary implications.
Grains Could See Reduced Demand
Grain markets may not be immune to the above slowing in demand. A case could be made that these markets have not yet experienced the major impact of Asian fallout. In particular, feed grains could be hurt. With a record soybean crop and the third- largest corn crop in history, there is certainly enough product available. Given this huge supply, these markets will be particularly vulnerable to reduced demand. This leads us to a pessimistic view in months to come for the complex.
Supply Increases Pressure/Copper In League With Asian Crisis
The most obvious casualty of the Asian malaise has been base metals. These often predictive markets have been under pressure for months as they anticipate reductions in new construction and a general decline in new infrastructure initiatives. Copper was faced with substantial supply increases from Chile and elsewhere even before the Asian situation manifested itself, and like the above feedgrains sector it is very vulnerable to a drop in demand. Japan is one of the world's leading aluminum consumers and as a result aluminum has been struggling despite solid North American and improving European offtake. This is typical for base metals. At some point, probably in late first quarter 1998, traders will have discounted these factors but in the interim lower prices are likely in store.
OPEC Likely To Raise Production Ceiling
The OPEC meetings will take place in Jacarta shortly and the major focus will be Saudi Arabia and a new production quota. It is fully anticipated that OPEC will increase its current quota ceiling of 25.033 million bpd to a more realistic level that reflects actual OPEC production of about 27.8 million bpd. The Saudis have already made their position clear that they want quotas raised. OPEC has not had a meaningful change in its official quota since September 1993 but obviously they have been producing much more. Senior Energy Analyst Michael Rothman feels that the market has already discounted a new quota of 27.0 million bpd. Looking ahead for the next few months the Asian demand impact and winter weather will be among the major areas of focus. Speaking of weather, while it is premature to draw a final conclusion, the early positioning of the jet stream seems to be setting up for above-normal winter temperatures in the Northern U.S. which would be a typical pattern for an El Nino year.
(Reprinted by permission. Copyright © 1997 Merrill Lynch, Pierce, Fenner & Smith Incorporated.)
November 26, 1997David Horner
Merrill Lynch & Co.
Global Securities Research & Economics Group
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