From the late 1990s until the financial crisis in 2008, most commodities experienced double-digit annual real (inflation- adjusted) price growth, a period known as the commodity “supercycle.”

The cycle extended despite the fallout in the economy with the rapid increase in the liquidity and monetary easing called QE in the developed world led by the US and Japan. Now as the tide of liquidity turns, commodities need to return to demand-supply dynamics and prices should readjust to that.

It is more or less an established fact that the era of monetary easing is coming to an end and the US Fed is gradually heading towards winding up its bond purchases. And if the economy sustains, the Fed might even reverse some of its purchases.

The debate on possible interest rate hike is restricted to the time line rather than on whether the rates will be raised or not. In such a scenario, commodities, which have benefited a lot from such liquidity, are bound to react.

Gold and monetary easing

Precious metals are the ones most affected by the financial stress and liquidity with low rates. We have seen the carnage in these over the last year and half as they reacted to the mere halt of the expansion of the QE.

Gold is a financial asset without any monetary reward for holding, except price rise. It has a proven track record for protecting purchasing power and being a haven in distress.

If gold prices have to move up, it either needs economic fallout such as 2008, where every other asset is sold in distress and the capital finds shelter in gold.

Or it needs really cheaper money (low interest rate) and a flood of liquidity. With none of these factors in place, currently gold prices are dangling around $1,300 levels only on the hope of a few investors, who expect the precious metal to repeat its stellar performance of the last decade.

Also, there are people who bat for gold on the basis of inflation expectations. I am not a strong proponent of that theory that failed drastically over the last few years when inflation across the world, except in few emerging nations, was negligible.

Despite this, gold rallied smartly. So, most of the inflationary expectations have already been priced in and with the monetary tightening, inflationary expectations have also toned down.

There are few gold bulls who are talking about cost of production, providing support to gold, For that matter, commodities can trade significantly below their cost of production levels for an extended period. We have seen this in the case of copper (after 2008) and nickel over the last year or so.

The cost of production varies significantly from old miners to the new ones and a few reopened ones. Let us consider two largest companies by market cap: Barrick Gold and Gold Corp.

Barrick’s production cost is $910 (operating cost of $566) and Gold Corp’s cost of production for the fourth quarter last year was $810 (operating cost is $553).

So, there is a long way to go. With this as back drop, gold prices do not have any major upside left; but the downside can be protected by the resumption in demand at lower levels giving some temporary boost.

Fundamentals

A sudden spurt in unemployment rate in the US may give gold a chance to rise temporarily, but overall the fundamental direction still shows south.

Smaller cousin silver will certainly follow gold but there can be a little more drama and more vengeance on the down side. We look at $1,080 for gold and $18 for silver as more sustainable supports.

Crude oil outlook

Crude oil is another active financial commodity which has a large concentration of fund positions.

The secular bull trend in energy prices was driven largely by the supply side triggers before the monetary expansion kicked in and a very attractive carryover has led to large inventory creating an artificial demand aiding the price rally.

Things took a dramatic turn on the crude oil front with Iran’s supply side challenges and Saudi Arabia’s spare capacity.

Demand scenario

Now, with geopolitical worries easing, the possibility of Iran oil restoring to previous levels and Iraq’s barrels flooding the market could leave the market well-supplied. On the demand front, though, there is a mild incremental growth expectation. Supply will overpower demand, leaving crude prices fundamentally bearish.

With the latest disappointing numbers from the world second largest consumer China, there are already enough doubts on the demand growth.

Though there is not enough visibility for WTI crude going down below $87 as of now, the upside seems pretty much capped at $110/barrel.

Base metals

On the industrial metals side, copper has been the one of the predominant source of rising short term funding in China, where a large amount of metal is stuck in such financing deals.

Increasing interest rates mean liquidation of those deals and release of vast quantities of metal in the market making the copper one of the bearish bets.

Zinc and lead are the two metals which missed the commodities super-cycle, and instead went through a long period of a consolidation.

These two metals were weighed down by consecutive years of surplus and high inventories.

However, the sentiment is now changing and there could be strength coming up in these smaller metals.

At the same time, aluminium – one of the most underperforming metals in the recent years – is set to climb up slowly.

Farm goods

Agricultural commodities do not have much correlation with monetary policy but are driven by the weather and changes in demand.

With the emerging world still continuing to grow at moderate pace, demand keeps rising and with weathermen predicting El Niño this year, this is the space to be watched for in the coming months.