Rally in base metals in FY22 unlikely to be as strong as in FY21, says Sugandha Sachdeva of Religare Broking

Brent prices have come a long way from November 2020 lows of around $35 per barrel to $70 per barrel in March 2021, a sort of a vertical rise in a short span. Improved fuel demand prospects amid easy monetary policy across the globe, continued fiscal support and the accelerated pace of vaccination helped prices to witness a sharp upswing. Major consumers such as China and the US have seen a strong rebound in economic activity as indicated by a whole range of data points, while demand from India has also been strong post lockdown situation seen last year.

Another major factor acting as a tailwind for oil prices has been the deep production cuts from the OPEC+ alliance and voluntary production cuts of another 1 million barrels per day (mnbd) taken on by Saudi Arabia since the beginning of February and extended through April. Additionally, an attack on the Saudi oil facility pushed the prices higher. However, prices have cooled off recently, almost 14 percent from their recent highs and, are presently in a corrective mode. The resurgence of COVID-19 cases, reinforcement of lockdowns in several countries, slow pace of vaccination drive in Europe and the recent decision by the OPEC+ for gradual increases in supply from May through July have weighed on the prices. Also, there are concerns about supply from Iran flooding the market, as talks have begun with the global powers in Vienna to lift the two-year-long sanctions on its oil and revive Iran's compliance to the troubled nuclear deal.

Underscoring the current scenario, this corrective phase may last for a while, as the demand looks to remain slightly feeble in the near term and rising supply looks to cast a shadow on prices but the level of $45-44 per barrel is likely to underpin prices.

Down the line, the market is anticipating global economic recovery to gather pace amid massive liquidity infusion and a low-interest rate regime. The International Monetary Fund (IMF)  is projecting a global growth of around 6 percent this year, which is the highest since the 1970s. That shall lead to a steady decline in global oil inventories and likely keep oil prices buoyant. The pace of vaccination has again picked up in Europe and also as summer is here, which typically sparks travel-related demand in western countries, it would continue to support prices. One should also not ignore the fact that crude oil is still much below its lifetime peak and has not even surpassed the highs of the last year, while base metal complex, which is a key indicator of global economic conditions, is hovering near multi-year highs. So, we expect the oil prices to consolidate for a while at lower levels and in due course find an upwards path towards $83-85 per barrel in FY22.

Gold remained range-bound after falling 20 percent from record highs. What could be the trend in FY22? What are the chances of the precious metal falling fall below $1,500 an ounce or rising to $2,200?

Certainly, we are missing the charm, what we had experienced last year in gold prices. Prices have closed Q4 FY21 in the negative territory after almost nine quarters of pronounced upside. Forecasts of a global economic expansion this year and broadly upbeat sentiments in the global equities have dimmed the appeal of the safe-haven asset. We have also witnessed a rebound in the greenback from almost three-year lows, while sovereign bond yields have been steadily creeping higher, as the global economy has been showing strong signs of recovery since the latter part of the year 2020.

Investors liquidated their holdings in gold and switched to riskier assets amid breakthroughs in vaccine development, easing lockdown restrictions and a pickup in economic activity. But then this corrective phase seems reasonably justified after the steep advance witnessed last year. This prolonged phase of correction has made gold attractive as a bargain buy with fundamental factors favouring a recoup in the precious metal. The lockdown situation in Europe has yet again raised concerns about economic revival in the near term, whereas India is struggling with a rapid rise in COVID-19 cases. This poses downside risks to the global economy, where recovery has already been quite uneven. Also, the Fed's commitment to keep its monetary policy accommodative along with the recent $2 trillion infrastructure package signals easy money supply is likely to remain available.

The other major narrative is inflation overshooting expectations later this year amid excesses in fiscal and monetary policy that can eventually fuel the rise in gold prices. Besides, record imports of 321 tonnes in the Q4 FY21, up from 124 tonnes a year ago, are indicative of a strong interest in the yellow metal at lower levels.

On the contrary, the major risk to gold is the fact that as the pandemic starts to fade and the economy starts to boom towards the later part of the year powered by vaccination drive along with supportive measures taken by the central banks, it could force the US Fed, in particular, to dial down its ultra-easy policy stance.

In terms of the price outlook, gold prices have had a bumpy ride in Q4 FY21 but formed a key base at the $1,680 per ounce mark, a support level that we have maintained since the beginning of the year. Brushing aside some volatile swings, the precious metal still looks to attract demand around these levels but needs to nudge past $1,765 per ounce to continue with the current phase of recovery.

For the near term, the upside looks restricted near the $1,960 per ounce mark. On the flip side, only a breakdown below the $1,680 per ounce mark could lead to a further downwards drift, where $1,550 per ounce could be seen as the next saviour for prices. As of now, we expect gold prices to trade in a wide range as per the suggested levels.

Nonetheless, from a longer-term perspective, the precious metal can still return to levels above $2,000 per ounce and even test levels of close to $2,270 per ounce, as we anticipate an inflationary burst due to the massive scale of stimulus that may spoil the party for risky assets and entice investors to return to gold as a hedge against currency debasement.

What is your outlook on the rupee in FY22?

The rupee traded in a contracting range during the fourth quarter of FY21 and closed with losses of around 0.15 percent in the same period. Sustained portfolio inflows, booming equities and strong signs of recovery in the domestic economy supported the domestic currency, while strength in the greenback capped the gains. However, the situation has turned slightly different now. We have a lot of uncertainty arising from the spike in COVID-19 cases, which is acting as a drag on the nascent stage of recovery from the pandemic-led abyss. Besides, rising crude oil prices are indicating that long-dormant inflation will soon take off, thereby hurting the sentiment for the domestic currency. Also, the strengthening greenback and notable rise in US bond yields amid an improving outlook for the US economy have been other major headwinds for the local unit. On the contrary, foreign portfolio inflows that have no doubt slowed down are still providing a cushion to the rupee exchange rate.

Facing a stiff hurdle at the 72.20-mark, the domestic currency has reversed course in a steep manner at the onset of the current financial year. The 72.20-mark coincides with the same level, a breach of which essentially fuelled a considerable fall in the domestic currency during March 2020. In the given backdrop, we expect the Indian rupee to witness further depreciation against the US dollar towards levels of around 76.50-77 from a medium-term perspective. Moving further ahead, we feel that the rupee will trade in a broad range of 72.20-77 for FY22, as a combination of pent-up demand and ample stimulus measures will gradually repair the economic scars of the pandemic and provide respite to the local unit towards the later part of FY22.

What do rising US bond yields and dollar index mean for the commodities market?

As a general trend, US bond yields and the dollar index have an inverse relationship with commodities. When bond yields rise and strength in the dollar is seen relative to other currencies, they normally weigh on the commodity prices. When the value of the dollar rises, commodities tend to effectively turn costlier measured in other currencies, which reduces their demand.

If we look at the present scenario, vaccination drives, easy monetary policies and overwhelming stimulus packages have powered faster-than-expected economic recovery and favoured rise in commodity prices in the process. But then they have also stoked inflationary concerns and participants are sceptical about the Fed's assurance to continue with its accommodative stance. With the expectations of strong economic expansion and inflationary pressures building up, US bond yields have risen to one-year highs and favoured interest in the greenback. On the other hand, gold, a non-interest yielding asset, has lost some of its shine, after it outpaced most of the assets last year.

What is your reading of base metals for FY21 and what could be the trend in FY22?

The unprecedented fiscal and monetary policy measures across the globe amid the COVID-19 pandemic, weakening of the US dollar and prospects of a powerful economic upswing due to the emergence of effective vaccines turbo-charged the rally in the base metals pack in FY21. Besides, strong demand from China and credit growth gave a thrust to copper prices, where they rose to a nine-year high at the LME.

On the supply side, copper output plunged in 2020, which further kept the prices buoyant. Robust demand prospects from the electric vehicles segment also provided a fillip to nickel and copper prices, largely supported by the green energy initiative adopted by China. Overall, it was a spectacular year for base metals, which caught everyone by surprise, supported by the recovery in China’s manufacturing sector, supply constraints and, investors contemplating a brighter post-COVID economic outlook.

Moving forward, the production is returning to pre-pandemic levels and the dollar index is recouping for the last two months, which may act as a headwind for the base metals in the short term. Furthermore, rising stocks at LME and SHFE registered warehouses and the threat of new mutants of COVID-19 spreading fast around the world may put pressure on base metals prices in the first half of FY22. Also, it seems that there have been speculative excesses in the base metals in the recent months on the back of positive sentiments from China but as the supply constraints are expected to ease, prices may witness some profit-taking in the first half of FY22.

The uncertainty over global economic recovery and the trade disruption will also be the key factors to watch out for this year. Also, China may put a brake on its spending plans to avoid over-heating of the economy. However, looking at the strong positive momentum in the industrial metals, prices are likely to resume with their upwards journey during the second half of the year, after a brief period of correction and consolidation.

Combined government and central bank stimulus of around $22 trillion since last year, will gradually work its way to ensure a strong global economic growth trajectory. Though the rally in FY22 is not expected to be as strong as the one witnessed in FY21, still the base metal complex is expected to tread on an upwards incline towards the latter part of FY22.

What are the key factors to look at in FY22 with respect to commodities?

The key factors to look out for would be the pace of global economic recovery, the trend of the US dollar and bond yields in particular. Markets would also remain closely concerned about the spike in COVID-19 cases in certain countries, renewed lockdowns to curb the virus spread in some parts of the world and supply bottlenecks in the vaccine rollout. Besides, fiscal support measures, the monetary policy of the US Fed particularly, inflationary pressures and the trend of the Indian rupee would have major ramifications for the commodity prices. Furthermore, oil supply from the OPEC+ alliance, US shale production and, geo-political risks would continue to steer the price of crude oil.

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