THE S&P GSCI (previously known as the Goldman Sachs Commodity Index) is a composite index of the commodity sector tracking 24 exchange traded futures contracts in the energy, industrial metals, precious metals, agriculture and livestock sectors.
In terms of weight, the oil and gas sector is heavily weighted on the index, with the price of the WTI crude oil alone making up almost a quarter of the index, while the sector itself is approximately 58.5% of the index. Other commodities like corn, copper and gold make up another 13.6% of the index.
The S&P GSCI is presently down 7.8% year-to-date while from its 2018 peak on Oct 3, the index has now given up about 18.8%, just 1.2% short of technically being in the bear market. The clear drop in the index is attributable to the drop in the WTI crude oil price, which has fallen some one-third while Brent has dropped 31% from its 2018 peak. The fall in oil prices is both a boon and bane for markets, depending if a nation is an exporting or an importing country of the product.
For Malaysia, it is obviously a negative development, as we expect Brent oil prices to average US$72 per barrel next year based on the Budget 2019 assumptions to enable the government to realise its revenue projections of approximately RM81bil (RM30bil special dividend; RM24bil in normal dividend; Petroleum Income Tax of RM18bil and payments in royalties, duties and contribution from the Malaysia Thailand Joint Authority totalling all in about RM9bil).
It is said that for every US$1 change in Brent prices, Malaysia’s tax revenue is impacted by approximately RM300mil. Based on Brent’s current price of about US$59.50 per barrel, we are potentially looking at a shortfall of RM3.75bil.
Market forecast for Brent in 2019 is still rather bullish, with the Brent expected to average US$75.50 per barrel in 2019 according to a survey by S&P Global Platts of 11 top oil forecasters, while the US Energy Information Administration expects Brent to average US$72 per barrel, similar to our own government’s forecast. Hence, perhaps, for the time being, we should not be too concered about the sharp correction that we have seen so far in the global oil market prices, as the market believes that prices will recover from their current low levels, mainly brought about by excess supply and relatively higher stockpile levels.
However, what we need to be concerned about is the fall in other commodity prices, in particular, palm oil. Last seen at RM2,027 based on the February 2019 crude palm oil (CPO) futures contract, CPO prices have fallen about 20% year-to-date mainly due to stockpile issues as well as oversupply. This has also hurt earnings of Malaysian planters, with a slew of them even reporting quarterly losses in the recently concluded third-quarter reporting period, which is rather rare.
The saving grace is that similar to crude oil, market forecasts for CPO are still decent at about RM2,300 to RM2,400 per tonne, well above water, especially with the higher minimum wage next year. Hopefully, the implementation of the government’s move to roll out the B10 and B7 biodiesel programme for the transportation and industrial sector by Feb 1 and July 1 next year, respectively, can reduce the current high stockpile that the sector is experiencing. Based on current estimates, the biodiesel programme will have an offtake of about 761,000 tonnes or about 28% of the nation’s current stockpile of 2.72 million tonnes as at end-October 2018.
The fall in commodity prices has also skewed market expectations of the pace of inflation we are going to see in 2019. The Fed chairman’s recent comment that the current interest rate level is “just below” what is deemed as “neutral” basically signalled a dovish stance, and should commodity prices remain weak next year, we are likely to see a lower actual rate of inflation. Thus, if inflationary expectations globally are to be reduced even by 0.2 or 0.5 percentage points, it is enough for central banks around the world to turn dovish or less likely to raise rates, or even if rates are raised, the pace of increase will likely be slower. This is likely if the current low commodity prices stay a little longer in 2019, especially with the ongoing trade spat between the US and China on trade and tariffs.
As it is, the market has already scaled back the expected rate hikes in the US to just one hike of 25bps.
A lower number of hikes in US interest rates in 2019 is enough for the dollar bulls to take monies off the table, as the greenback, which is up 5.1% year-to-date and 9.3% since its February 2018 low, is unlikely to continue its fine run if the number of rate hikes is reduced by two-thirds. For Malaysia, this is also positive, as a weaker dollar will allow the ringgit to regain some lost ground and perhaps dip below RM4.00 to the dollar by the first quarter of next year.
With this, markets will be in a jubilant mood as a slower pace of increase in rates due to lower inflation expectations, brought about by falling commodity prices, will see investors returning to the market. One way to judge this is to look at US Treasuries or even other sovereigns as benchmark yields will likely go lower as bond prices rise. As it is, the 10-year US Treasuries have dropped 23bps from its recent peak of 3.26%, although the spread between the 10-year and two-year has maintained its narrowing path and last seen at just 22bps.
Hence, how commodity prices behave in 2019 is going to be crucial not only for economic growth projection but also profitability of companies, expectations on inflation rates, interest rates and last but not least markets, both on the equity and fixed income investors.