Given concerns in Japan, conflict in the Middle East and the potential impact on oil supply and therefore oil prices, there has been rotation out of the more leveraged mining sector into the more defensive energy sector.
With high oil prices threatening to limit global economic growth and the Chinese credit tightening to limit inflation, there is also uncertainty around base metal and bulk material demand. This has led to the materials sector continuing to underperform and, while valuations are now looking more attractive, there is still caution.
However, if Chinese inflation peaks later in the year, this may indicate an end to the tightening cycle and the perceived macro threat of slower growth from China will be likely to recede. The 12th five-year economic plan was approved this month and there was more of the same from China as much of the current leadership is set to retire within the next 12 months. Their plan is supportive of thermal coal, coking coal, iron ore and copper as west and central China experience industrialisation.
With the focus now on oil prices as the conflict in Libya intensifies and a no-fly zone being enforced, energy and precious metals are rising while commodities linked to growth such as base metals are trading sideways or trading down, although iron ore has recovered.
Recent price rallies in the agricultural sector are beginning to mature and strong production responses for certain agricultural commodities are expected for the next crop year as a result of increased plantings and fertiliser application.
In equities, a similar split is emerging as investors are concerned about higher oil prices impacting global growth, industrial production, consumer spending and whether demand can continue to recover in the face of higher energy price rises and potential interest rate hikes at the same time as inflation re-emerges.
Companies have, however, generally reported strong earnings results over the past month. This has been supported by continued mergers and acquisitions activity given cheap financing.
The economic outlook remains bullish for commodities as growth in the global economy remains resilient. This is a reflection of a series of factors. The rise in oil prices has been primarily due to a recovery in demand, rather than the recent supply disruptions. Monetary policy has been accommodating and has allowed economies to absorb higher oil prices.
The share of energy in most economies is significantly lower than in the 1970s. Having said this, we believe oil prices rising to levels above $125 per barrel for a prolonged period of time, could present a threat to recovery.
