Commodity Downdraft Reintensifies Widespread selloff in July and August

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Virgil Gibson
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A monthly commodity watch August 2015 Commodity Downdraft Reintensifies Widespread selloff in July and August The BMO Capital Markets Commodity Price Index plunged 7.

Although the index remained a touch above its recent bottom in July, it is set to break new ground to the downside in August, with WTI now below $40 and global risk assets under pressure due to

1 A monthly commodity watch August 2015 Commodity Downdraft Reintensifies Widespread selloff in July and August The BMO Capital Markets Commodity Price Index plunged 7.6% in July as crude oil resumed its tailspin and metal prices slumped to new lows. The broad-based decline hit 13 of 19 covered goods, seven of which fell to lows not seen in five years or more. Although the index remained a touch above its recent bottom in July, it is set to break new ground to the downside in August, with WTI now below $40 and global risk assets under pressure due to concern over China s economic slowdown. The Oil & Gas Index resumed its downtrend in July, reflecting a 14.9% plunge in crude oil. The nuclear deal with Iran and rising concern about China s economy unsettled the oil market, which is still facing significant excess supply. While demand- and supplyside responses to low prices are occurring and will eventually balance the market, this is not likely to become more evident until later in 2016 and in Natural gas prices have stabilized after falling through much of 2014 and early 2015, with U.S. benchmark Henry Hub trading in a monthly-average range of US$2.60-$2.85 per million British thermal units since March. The Metals & Minerals Index dropped 4.1% in July thanks in part to the strengthening U.S. dollar. The steep downward trend in base metals extended into August, as soft economic data, a tumbling stock market, and Beijing s unexpected currency adjustments raised concerns about China s growth prospects. In contrast, the yuan s devaluation and the recent sell-off in global equities have prompted a rush to safety, which has pulled precious metals away from lows reached earlier in August. Critical to the near-term price trend will be the Fed s coming decision on interest rates, which will affect both the greenback and investor appetite for nonyielding commodities. The Forest Products Index slid 0.6% in July, reflecting declines in most components. Wood product prices buckled during the month, with OSB sliding on overcapacity and lacklustre demand. Although spruce-pine-fir ticked up in July, the monthly move conceals a large downward swing toward the end of the month that deepened into August, partly reflecting the stronger U.S. dollar. The lofty greenback was also at play in the paper market, with newsprint and supercalendared paper both down notably in July, though demand has disappointed as well. As a result, the outlook in both markets has been trimmed considerably. The Agriculture Index gained 2.4% in July as concern about global growing conditions triggered rallies in wheat and canola, which more than offset a moderate decline in livestock prices. Most recently, crop prices lost ground in August on unexpectedly bearish USDA projections and, to a lesser extent, as declining metal and energy prices caused some investors to flee the commodity space altogether. ECONOMIC RESEARCH Earl Sweet, Senior Economist & Managing Director earl.sweet@bmo.com Christy Chen, Senior Economist christy.chen@bmo.com Alexandros Koustas, Economist alex.koustas@bmo.com Aaron Goertzen, Economist aaron.goertzen@bmo.com All Commodities Index BMO CAPITAL MARKETS COMMODITY PRICE INDEX (3 = ) A Publication of BMO Capital Markets Economic Research Douglas Porter, CFA, Chief Economist Jul. Level % Change from (3=) Mth. Ago Yr. Ago All Commodities Oil & Gas Metals & Minerals Forest Products Agriculture

2 Page 2 of 9 August 2015 Commodity Focus: Base Metals Hit by a Combo Punch Christy Chen, Senior Economist The downturn in base metal prices has extended into its fifth year, the longest since the early 1980s. Sharp corrections in 2011 and over the past 12 months have led to a 40% plunge in the CRB metal sub-index from its previous peak. This is the second biggest cyclical retreat over the past 35 years, only exceeded by the deep dive in 8. Although prices have tanked, we expect that markets will remain lacklustre or even test lower levels by the end of 2016, given strong headwinds blowing from multiple directions. In this cycle, the new normal of slower growth in China is clearly the number one factor pressuring prices, as the country accounts for about half of global consumption of base metals. Although China s Q2 growth managed to meet its 7% target, recent soft economic data (including weaker growth in exports and the lowest manufacturing PMI reading in six years) and volatile stock prices suggest that the economy is facing downside risks. China s industrial production has been slowing steadily over the past five years, with y/y growth in output of motor vehicles and many fabricated metals and household electronic products falling into negative territory. As base metals are widely used in these industries, China s share of global demand for these metals has peaked, and for some, has declined. To curb the economic slowdown, policymakers have cut interest rates and implemented aggressive policy interventions. Nevertheless, some measures introduced a high degree of market volatility Beijing s stockmarket bailout in July and its recent unexpected currency adjustments raised market concern about the country s growth prospects, sending the CRB metal sub-index down another 4% over the first three weeks of August. On top of weaker demand in China, the strengthening U.S. dollar exacerbated the downward trend in prices. As commodities are priced in dollars, the rising greenback increases the cost of imports and thereby reduces demand. On the supply side, with the U.S. dollar climbing and energy prices falling, cost curves have shifted down notably in non-u.s. markets over the last two years, keeping mineral producers profitable despite sharp declines in prices. It is estimated that around 75% of copper mines today can break even on a C3 1 cost basis if the copper price stays near its recent level CHART 1: CHINA S METAL CONSUMPTION SHARES (% of world total : 12-month m.a.) Zinc Nickel Aluminum Copper CHART 2: METAL PRICES AND US$ 700 CRB Metals Sub-Index¹ (lhs) 6 Jul 14 Oct Jan 15 Apr Jul 1 (1967= ) 2 (January 1997 = ) Broad Tradeweighted US$² (rhs) CHART 3: GLOBAL METAL STOCKS (days of consumption) Zinc Nickel Aluminum Copper forecast C3 refers to fully allocated cost, which is the sum of the net direct cash cost (C1), depreciation, depletion, amortization, indirect costs and net interest charges. C1 represents the cash cost incurred at each processing stage, from mining through the recoverable metal delivered to market, less net by-product credits.

3 Page 3 of 9 August 2015 (US$2.34/lb). By comparison, based on the C3 cost curve in 2013, less than 60% of producers would have been able to make money at current prices. Even if the Fed delays rate hikes, the U.S. dollar should strengthen further in 2016 on eventual monetary tightening, which suggests that cost curves are likely to move down further and that prices still have some room to fall before generating enough restraint in supply to begin balancing markets. CHART 4: COPPER NET SPECULATIVE POSITIONS (000s of contracts) Slow reactions from the supply side also relate to high fixed capital -10 costs and long development timelines of mining projects, which slows the scaling-back of investment in large projects started -20 during the previous bull run. For example, although capital -30 spending has been trimmed over the past two years in the -40 Canadian mining and primary metal manufacturing industries, its - share of aggregate capital investment in Canada is still well above levels seen prior to the 8-9 recession. As a result, capacity utilization in these industries is running lower than in other sectors. From a global perspective, stocks of aluminum and nickel relative to underlying consumption remain notably higher than their historical norms, suggesting excess output continues to be a burden and further supply curtailment is needed to balance markets and stabilize prices. Adding to these weak medium- to longer-term fundamentals is bearish short-term market sentiment. Reports from the Commodity Futures Trading Commission (CFTC) show that speculative net short positions in COMEX copper have increased sharply over the last four weeks, moving closer to the record high (record negative position in the accompanying chart) reached in January. Traders are betting the worst is yet to come for the metal. That said, this could also suggest limited downside ahead as net short positions are already at unusually high levels and are therefore not very likely to be increased much further. Overall, despite the significant correction already seen during the last few years, the outlook for base metals remains cloudy. Economic growth in China is projected to slip below 7% later this year, the upward trend in the greenback is expected to stretch further through 2016 on rate hikes, while cuts to mineral production could continue to lag price movements. This implies a challenging backdrop for base metals over the next 12 to 18 months, which won t help the stumbling loonie

4 Page 4 of 9 August 2015 Energy and Materials Crude Oil Natural Gas (WTI) (Henry Hub) (Alta. Empress) Lumber Pulp Newsprint US$/bbl US$/mmbtu US$/mbf US$/tonne y-t-d August September October November December January February March April May June July m-t-d August n.a. n.a. n.a. Forecast 2015 Avg Avg Commodity price forecasts are by BMO Capital Markets Economics and are independent of those used by BMO Capital Markets Equity Research. and indicate annual forecast changes from last month.

5 Page 5 of 9 August 2015 Base and Precious Metals Copper Aluminum Zinc Nickel Gold Silver US$/lb US$/oz y-t-d August September October November December January February March April May June July m-t-d August Forecast 2015 Avg Avg Commodity price forecasts are by BMO Capital Markets Economics and are independent of those used by BMO Capital Markets Equity Research. and indicate annual forecast changes from last month.

6 Page 6 of 9 August 2015 Agriculture Wheat ¹ Canola Cattle ¹ Hogs ¹ US$/bushel US$/tonne US$/cwt n.a. n.a n.a. n.a n.a. n.a y-t-d August September October November December January February March April May June July m-t-d August Forecast 2015 Avg Avg Commodity price forecasts are by BMO Capital Markets Economics and are independent of those used by BMO Capital Markets Equity Research. ¹ Due to a change in the U.S. Department of Agriculture s data dissemination schedule, the BMO Capital Markets Commodity Price Index now tracks CME wheat, lean hog, and live cattle futures prices. and indicate annual forecast changes from last month.

7 Page 7 of 9 August 2015 Commodity Indices and Forecasts All Oil & Metals & Forest Agricultural All US$-terms : 3 = Annual Commodities Gas Minerals Products Products Commodities C$-terms Forecast Quarterly 2013 Q Q Q Q Q Q Q Forecast Q Q Q Monthly 2014 Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Commodity price indices and forecasts are by BMO Capital Markets Economics. Forecasts are independent of those used by BMO Capital Markets Equity Research.

8 Page 8 of 9 August 2015 Historical Charts: All-Commodity Index Nominal US$-Terms (3 = ) Real US$-Terms (3 = ) Nominal (3 = ) US$-terms 2 1 C$-terms

9 Page 9 of 9 August 2015 Technical Note The BMO Capital Markets Commodity Price Index is a fixed-weight, export-based index that encompasses the price movement of 19 commodities key to Canadian exports. Weights are each commodity s average share of the total value of exports of the 19 commodities during the period Similarly, weights of sub-index components reflect the relative importance of commodities within their respective product group. The all-commodities index and sub-indices consist of the following: Weight in Weight in All-Commodities Weight in All-Commodities Weight in Percent Index Sub-Index Index Sub-Index Metals & Minerals Forest Products Gold Newsprint Silver Market Pulp Aluminum Supercalendered Paper Copper Lumber Nickel OSB Zinc Uranium Agricultural Products Potash Wheat Canola Oil and Gas.5.0 Hogs Crude Oil Beef Cattle Canadian Natural Gas All Commodities.0 Unless otherwise specified, all indices reported in this publication correspond to prices in U.S. dollars. General Disclosure BMO Capital Markets is a trade name used by the BMO Investment Banking Group, which includes the wholesale arm of Bank of Montreal and its subsidiaries BMO Nesbitt Burns Inc., BMO Capital Markets Ltd. in the U.K. and BMO Capital Markets Corp. in the U.S. BMO Nesbitt Burns Inc., BMO Capital Markets Ltd. and BMO Capital Markets Corp are affiliates. Bank of Montreal or its subsidiaries ( BMO Financial Group ) has lending arrangements with, or provide other remunerated services to, many issuers covered by BMO Capital Markets. The opinions, estimates and projections contained in this report are those of BMO Capital Markets as of the date of this report and are subject to change without notice. BMO Capital Markets endeavours to ensure that the contents have been compiled or derived from sources that we believe are reliable and contain information and opinions that are accurate and complete. However, BMO Capital Markets makes no representation or warranty, express or implied, in respect thereof, takes no responsibility for any errors and omissions contained herein and accepts no liability whatsoever for any loss arising from any use of, or reliance on, this report or its contents. Information may be available to BMO Capital Markets or its affiliates that is not reflected in this report. The information in this report is not intended to be used as the primary basis of investment decisions, and because of individual client objectives, should not be construed as advice designed to meet the particular investment needs of any investor. This material is for information purposes only and is not an offer to sell or the solicitation of an offer to buy any security. BMO Capital Markets or its affiliates will buy from or sell to customers the securities of issuers mentioned in this report on a principal basis. 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Page 2 of 7 March 2019 Energy and Materials Crude Oil Natural Gas (WTI) (Henry Hub) (AECO) Lumber US$/bbl US$/mmbtu US$/mbf 2006 66.10 6.74 5.76 290 2007 72.36 6.98 6.02 245 2008 99.57 8.86 7.79 215 2009