Commodity recovery could face headwinds

China slump, rising greenback potential trouble

The recent resurgence in certain commodities such as oil, copper and zinc must feel pretty good to investors — especially those in Canada — who have been hit hard by the slump in natural resources in recent years.

But it may be better if investors hold off getting excited for now. The rebound could very well have legs, but it could just as easily fizzle in the days and months ahead, say analysts.

“After a dismal finish to 2014, dominated by the collapse in oil prices, sentiment towards commodities is turning more positive again,” said Julien Jessop, analyst at Capital Economics, in a note to clients.

“The revival in the energy sector has clearly helped, but the turn in sentiment is also consistent with the upbeat view we have expressed on commodities in general since the start of the year.”

Jessop expects commod- ity prices to keep rising, but said there are still some major downside risks for investors to consider, including the prospect of renewed strength in the U.S. dollar and the escalating crisis of Greece, which could undermine market sentiment.

Perhaps the biggest headwind of all is China’s ongoing economic slump and transition to a domestically led economy.

The country’s demand for commodities has been surprisingly strong across a variety of markets, including oil and copper, so far in 2015, but that demand is expected to slow over the rest of the year, said Barclays Capital Market’s analyst Kevin Noorish in a report.

Noorish said demand has been fuelled by a combination of factors including the increase in government infra- structure spending being made to combat decelerating GDP growth, as well as inventory building encouraged by the dip in prices.

“A combination of low prices and restocking has been important, and neither will last, so some slowdown should be expected,” he said.

“Nevertheless, extra government spending on infrastructure is real, as is the growth in car ownership and demand for air travel. So although we expect China’s demand growth to slow compared with Q1, for many commodities 2015 should still turn out to be a much stronger year than 2014.”

That may be true, but it’s unlikely that China’s economy will support a major shift in commodity sentiment anytime soon, said Vincent Delisle, portfolio strategist at Scotia Capital Inc.

He believes the country’s world-leading economic growth will continue to slow and become increasingly focused on domestic sectors.

As a result, while Chinese demand growth was the main driver of commodities from 2003 to 2014, supply issues for resources such as oil and iron ore, and a stronger greenback are now also very important to the future direction of prices.

“Commodities can stage a rebound, but it is unlikely to be exclusively China-driven,” he said.

Low prices and restocking have been important