By the commodities research team
Paul Horsnell, Managing Director, Head, Commodities Research
Suki Cooper, Executive Director, Precious Metals Analyst
Sudakshina Unnikrishnan, Executive Director, Commodities Analyst
Emily Ashford, Executive Director, Oil Analyst
The outbreak of COVID-19 has had a widespread impact across the commodities markets. Safe-haven assets like gold have rallied, while some commodities with significant exposure to China have come under pressure. Others, like palladium, have side-lined any potential demand weakness and set new highs. We have downgraded our global growth forecast for 2020 to 3.0 per cent from 3.2 per cent previously and downgraded our China 2020 GDP growth forecast to 5.5 per cent from 5.8 per cent, to reflect the longer-than-expected delay in restarting operations in China after the Lunar New Year holidays.
The unfolding COVID-19 situation and efforts to contain its spread have had a palpable impact on base metals supply and demand in China. Measures to contain it have included quarantines, an extended Lunar New Year holiday, and further delays to restarting work imposed by companies as well as provincial governments impacting labour movement. Further, logistical challenges have emerged, with restrictions around road transport leading to transportation by rail that involves queuing. This has impacted the transport of raw material, including delays to shipments of copper concentrate.
A specific issue around the storage and sale of sulphuric acid is proving problematic for copper smelters in China; this had been flagged to us when we visited China in November 2019. Smelters can only store limited amounts of sulphuric acid, and delays in selling and transporting it could lead to reduced utilisation rates and the scaling back of copper production. Further downstream, delays by fabricators in restarting production are likely to impact near-term copper demand, as are expected delays in restarting operations in the manufacturing and construction sectors.
While the COVID-19 has caused a significant negative shock, we think the parallels with the oil demand shock caused by the global financial crisis (GFC) in 2008-09 are limited. The GFC deflected global oil demand from its long-term path; while business as-usual rates of annual growth were eventually restored, the lost growth during the GFC was not fully recovered. By contrast, the SARS outbreak in 2003 appears to have had no lasting impact on global oil demand, which regained its pre-SARS path in 2004. We expect the oil demand consequences of COVID-19 to follow the longer-term pattern of SARS rather than that of the GFC. We expect global oil demand to slow to just 0.44mb/d in 2020 but to rebound to 2.34mb/d in 2021.
We do not think the oil market is currently pricing in a return to the long-term demand path. Indeed, much of the media and analyst coverage of the market describes the effect of COVID-19 as ‘demand destruction’. Used in the correct context, this is a precise technical term that implies that if the original conditions were restored, demand would be lower; i.e., some consumption would be permanently destroyed. We see no parallel with the coronavirus effect; demand is being temporarily depressed, not destroyed.
Gold prices are trading at 7-year highs as a flight to safety has buoyed investor demand and offset any weakness in the gold jewellery sector. Safe-haven buying tends to have a short-lived impact on prices; such price gains are not necessarily sustained. Such a rally is more likely to be extended on a negative shock that is likely to impact global growth and potentially trigger a recession. The recent price move is more akin to the market reaction when trade tensions escalated is 2018-19. The heightened uncertainty then had a diminishing impact on safe-haven buying until trade tensions became more widespread, and concerns arose that this might impact global growth, increasing the likelihood of recession in late May 2019.
Gold prices firmed during the 2003 SARS episode, but other structurally positive factors drove gold demand and price momentum then. In terms of physical demand, the SARS virus hit jewellery sales in China in Q2-2003; demand weakness may yet materialise, should COVID-19 follow a similar path to SARS. China’s gold demand fell 32 per cent q/q and 11 per cent year-on-year in Q2-2003, but China has become a much larger participant in the gold market compared to 2003. Full-year 2003 demand represents just one quarter of 2019 demand.
The physical market has softened, particularly jewellery demand. Several retail stores in China have noted likely downgrades to their sales, due to store closures across China as well as travel restrictions. Some jewellers have launched promotions, but some estimates suggest sales could fall as much as 70 per cent year-on-year in Q1-2020. Investor demand has a larger gap to plug, and has thus far been more than sufficient.
One commodity that has bucked the demand weakness trend has been palladium. Under current industry forecasts, China’s auto demand could fall as much as 200koz in Q1-2020. However, given our projected deficit forecast, auto production needs to fall by in excess of 30per cent to balance the market. The palladium market is set to remain undersupplied.