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Michael Savy Blog post by Michael Savy

2016 Global Economy & Equity Outlook (Part 3) | Commodities Market

Here are the other parts of the 2016 Global Economy & Equity Outlook:

Part 1: United States Economy
Part 2: Asian and European Economy
Part 3: Commodities Market
Part 4: Australian Economy

Ben Kingsley: So when we look at commodities, obviously the largest commodity is actually cash and the next commodity after that is oil and then iron ore for us. So let’s just spend a bit of time in talking about oil and general commodities. Where do you see the market in 2016?

Michael Savy: Look, the commodities cycle at the moment, obviously we’re at – we’ve got the issue of China transitioning their economy.

Ben Kingsley: Yeah.

Michael Savy: So we’re looking at the hard commodities. In fact we’re looking at the iron ore, the nickel and all those types of things. Obviously that has been depressing. It has been depressed for a couple of years now.

A lot of the analysts and a lot of the valuations that we see in a lot of the stocks at the moment are probably factoring in certainly lower, much lower long term average pricing on iron ore and those types of things.

Ben Kingsley: Yeah.

Michael Savy: On the oil side of things, that has certainly dropped quite significantly.

Ben Kingsley: Yeah. Bounced off, it slows at $26, but yeah …

Michael Savy: That’s right. It has bounced off at the moment, probably on the backend of some rumour and conversations about the Russians.

Ben Kingsley: The Russians and the OPEC getting together and China.

Michael Savy: Oil is an interesting one because we – at the moment, we probably got a production supply surplus of around about two million barrels a day.

Ben Kingsley: Yeah.

Michael Savy: The US is obviously still producing. I think the expectation of the Shell gas production is coming off – significantly hasn’t quite eventuated.

Ben Kingsley: Yeah.

Michael Savy: To the point that they actually built up their reserves late last year, hence we saw a bit of a drop.

Ben Kingsley: Yeah.

Michael Savy: The oil price is an interesting play in that when we look – when I spoke earlier about inflation being relatively low globally, it’s interesting that the core inflation is around about the two percent mark or just under.

Ben Kingsley: Yeah.

Michael Savy: But headline inflation is sub-one for a lot of these developed economies because of the impact of oil.

Ben Kingsley: Yeah. So basically for the listeners, what happens there is oil is involved in a lot of products that we use. So if the cost of that is significantly lower in the raw materials, that can potentially flow through to the actual realised price of those items.

Michael Savy: Yeah. So with the oil market at the moment, so we have a little bit of the supply glut, but also the other part of the equation is the demand, which is the conversation. I think on the demand side, that has been maintained.

Ben Kingsley: Yeah.

Michael Savy: Because if we look at China for example, their GDP was only 6.9 last year but on the flipside of that, they still managed to have an 8.8 percent increase in oil consumption. So if they do maintain the 6.9s and 6.5s, you should still expect some growth in demand in that space.

Ben Kingsley: Yeah, I think the US and the Northern Hemisphere coming out of their winter, which has been a pretty bad winter, so less – I think we will see some more consumption on that oil side, especially if it’s so cheap. So I suspect you will see the big forward drives getting around America and in Canada and those type of areas. So again, I think we will see probably more consumption at that price point.

Michael Savy: Yeah. So principally, the oil discussion is around supply side factors in that there are certainly some political games being played.

Ben Kingsley: Yeah.

Michael Savy: Economic games as well in that people are trying to protect the market shares or certain countries are trying to protect their market share. That’s probably one of the black swan events as well, given the price of some of the instability later in the year.

Ben Kingsley: Yeah.

Michael Savy: So obviously heavily-reliant countries such as Venezuela, Brazil and Russia, and particularly Russia. Given the oil prices, it is heavily eating into their budget deficits and reserves. So the longer this persists, the closer they are to potentially default on their government bonds.

Ben Kingsley: Yeah, OK.

Michael Savy: So that’s something to keep an eye out on.

Ben Kingsley: It’s an interesting point.

Michael Savy: Yeah. So we just need to be mindful of the fact that if the oil price stays too long – and which is probably why we find that the Russians are having conversations with people.

Ben Kingsley: Yeah. So iron ore, what do you say on iron ore?

Michael Savy: With the iron ore, unfortunately that’s probably going to stay reasonably low because – at current levels unlike the oil which is a supply side issue that can be quickly adjusted.

Ben Kingsley: Yeah.

Michael Savy: Iron ore on the other hand, we have both a supply issue, but significantly a demand issue.

Ben Kingsley: Yeah.

Michael Savy: In that China is …

Ben Kingsley: Slowing demand, yeah.

Michael Savy: Yeah.

Ben Kingsley: Yeah.

Michael Savy: So with the transition into the services or consumer base that don’t need as high levels of steel, but which – following from that though is that we’re looking at probably a better outlook on other commodities, hard commodities like aluminium.

Ben Kingsley: Yeah.

Michael Savy: Which is a second stage or second tier commodity in that – you know, once you build the roads and the cities, then you need the fridges and all the other lifestyle goods.

Ben Kingsley: Yeah. So aluminium. Any view on nickel and copper?

Michael Savy: Look, they’re both trading at historical lows. You could probably put nickel and copper again close to the second tier second stage commodities as well. But not withstanding that, all commodities are still being heavily depressed at the moment. So …

Ben Kingsley: So not a great year in the commodities space or the mining space but that being said, potential opportunities …

Michael Savy: Yes, absolutely. There are opportunities in that again sometimes we have to step away from the real world to the financial world in that the real world is driving the prices which is forcing a lot of pressure and profits on the stocks and the companies themselves, which if anything opens up the door for mergers and acquisitions. So we might start seeing a few more of these come through over the next 12 to 18 months.

Ben Kingsley: Yeah.

Michael Savy: Yeah. Obviously cash flows, being debt levels are going to be important. Companies are being marked down for their debt levels or mining companies on the stock markets being marked down for their debt exposures. The risk to dividend payments and those types of things if they’re not possibly generating cash flows in their operations. There will be a lot of cost cutting. So we will start to see more of that.

Michael Savy: Yeah. So there is that – from that perspective, I think there is that opportunity for mergers and acquisitions. I think the other factor is – the other black swan event I think in – relating to oil is probably the size of the hyper debt. So there have been some conversations and discussions about the spread in hyper debts – sorry, high yield debts in the US.

Ben Kingsley: Yeah.

Michael Savy: Because essentially a lot of these US companies, Shell gas operators, were borrowing money, issuing debt when oil was at $100 a barrel and any profits of future sales would be used to pay down the debt.

Ben Kingsley: Yes.

Michael Savy: But now that oil is trading at 30s and 40s, they’re obviously not going to be in a position to pay down some of that debt. So there is a concern with the level of debt in that space and any default in that …

Ben Kingsley: Yeah. I think there’s no doubt we’re going to lose a few of those Shell operators and I think that’s probably part of OPEC’s point in terms of flooding the market to a degree. Get rid of those cheaper operators out and then hopefully have a sustainable price point that they can then ensure that they can maximise until their oil runs out about 50 or 80 years.

Michael Savy: Yeah, yeah.

Ben Kingsley: True. So that’s a good wrap-up in terms of the commodities stuff. Let’s go over to …

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