Key points

• We discuss five themes which we believe will dominate commodity markets in 2010 as the role of the business cycle diminishes:
• #1: We expect correlations of commodities with other assets to fade as focus turns to individualspecific fundamentals.
• #2: We expect no new all-time highs in prices soon due to the stock overhang and the risk of a negative feed-back with growth.
• #3: Oil prices to be stabilised as OPEC keeps production in check.
• #4: Flatter curves in sight as market balances tighten on a pick-up in demand.
• #5: Asian appetite for commodities should continue to put a solid floor under prices.

The economic and financial crisis of 2008-09 was so significant that its consequences for a very long time have been dominating markets, including those of commodities. As a result, most asset classes have moved largely in sync for most of the past year, inducing unprecedentedly high correlations between, for example, commodities on the one side and equities, bonds and the dollar on the other. Indeed, market focus has so far primarily been on one common factor: the stance of the global business cycle. For commodities, this meant that the focal point became the prospects of a recovery in the global economy and, in turn, a come-back of demand for raw materials.

The dedicated reader of our Commodities Monthly might have noticed that we chose a largely cyclical approach to the commodity markets in 2009. Thus, our commodity-price forecasts were derived to a large degree from our economists’ relatively optimistic call on global growth during the course of 2009. Therefore, we in turn had a rather bullish view on commodities, and a fair amount of our projections came rather close to capture actual price developments.

Going forward, we expect the close relationship between the global business cycle, commodity prices and other assets to decline. This looks set to happen when the global recovery matures and the world’s central banks start to withdraw liquidity from the market. The latter should also reveal whether unsustainable price movements away from fundamentals have taken place. While the commodities segment as a whole is now to the high side of fundamentals as judged from our simple long-run model of the CRB index, see Commodities: A fair-value model of the CRB index, valuation still does not appear significantly overdone (see chart).

Going into 2010, we are, in our view, now in the process of moving to a situation where more traditional commodity-specific factors like supply, demand and stocks will once again play a pivotal role in the individual markets, see also our November Commodities Monthly. Thus, we anticipate that commodities in general will not necessarily continue to see close co-movements with other assets.

In this research note, we take a look at five different themes which we believe will dominate commodity markets in 2010 as the role of the business cycle diminishes. The themes are certainly not fully comprehensive, but they are an attempt to provide a guide to some of the major trends and themes that we believe will be crucial in 2010. We do not present any new price forecasts here but we will return with updated forecasts and introduce 2011 projections in the next issue of Commodities Monthly which is due to be published at the end of this month.

In the first theme, Correlations to fade, we take a closer look at correlations and causality in commodity market. We show that the high correlations between commodities and other assets in 2009 is a clear anomaly, and we anticipate that 2010 will put an end to this. We also take a look at a widely debated issue: the impact of speculators. We show that on a weekly basis, speculation does seem to impact commodity prices, but in the longer run this effect fades. Since we look for strong investor interest for commodities in 2010, we recommend keeping a close eye on investor flows to understand short-run movements in commodity prices.

The global economy has now moved out of recession and our economists are relatively positive on global growth in 2010. This raises the question if we are once again moving towards new highs in commodity prices. In the second theme, No new all-time highs soon, we argue that a huge stock overhang in most markets, spare capacity, notably in the oil market, and the risk of a negative feedback loop between, for example, oil prices and global economic growth should avert new record-high prices in the near term. Copper and gold are jokers though due to special factors at play in these markets.

In the third theme, OPEC still in charge, we take a closer look at the oil market and argue that OPEC will continue to be pivotal for the oil market in 2010. Despite declining compliance, we forecast that OPEC will be able to tighten the oil-market balance in the course of 2010 and thus stabilise crude prices above USD80 per barrel.

In the fourth theme, Flatter curves in sight, we present our view on the commodity curves in 2010. Basically, we argue that tighter market balances should lead to a flattening of most commodity curves this year and potentially move these from their current contango stance into backwardation. Should such a shift materialise, this would offer investors the opportunity to benefit from a positive roll yield and add to investor demand.

Finally, we cannot discuss commodities without mentioning China. In the fifth theme, Asia to put a solid floor below prices, we argue that Asia will continue to support demand for commodities in 2010. However, we underline that the positive demand surprises seen consistently during 2009 are not to be expected to the same degree this year. Focus will rather turn to the risk of expansionary monetary- and fiscal-policy measures in Asia - not least in China - being rolled back. The latter will almost inevitably be bearish news for commodities from time to time in 2010.

Full Report in PDF

Danske Bank http://www.danskebank.com/danskeresearch

Disclaimer

This publication has been prepared by Danske Markets for information purposes only. It is not an offer or solicitation of any offer to purchase or sell any financial instrument. Whilst reasonable care has been taken to ensure that its contents are not untrue or misleading, no representation is made as to its accuracy or completeness and no liability is accepted for any loss arising from reliance on it. Danske Bank, its affiliates or staff, may perform services for, solicit business from, hold long or short positions in, or otherwise be interested in the investments (including derivatives), of any issuer mentioned herein. Danske Markets´ research analysts are not permitted to invest in securities under coverage in their research sector. This publication is not intended for private customers in the UK or any person in the US. Danske Markets is a division of Danske Bank A/S, which is regulated by FSA for the conduct of designated investment business in the UK and is a member of the London Stock Exchange. Copyright (©) Danske Bank A/S. All rights reserved. This publication is protected by copyright and may not be reproduced in whole or in part without permission.

---