Key points:

• The more favourable USD has been a source of support for most commodity markets in the first half of 2016, but heightened uncertainty has seen additional volatility across financial markets, including commodity markets, more recently. Nevertheless, it is the fragile balance of other supply-demand factors that are most material to the outlook for commodity markets – especially given the context of a subdued global economic outlook (including for emerging markets) and ongoing production growth for key commodities.

• Uncertainty around the outlook for commodity prices has ramped up further in the wake of the recent Brexit decision. In contrast, emerging signs of strength in Chinese construction and heavy industries is encouraging, although the long-term sustainability of the rebound is debatable. On balance, market fundamentals suggest that the recent rally in NAB’s commodity price index will prove short-lived, and a gradual decline will recommence going forward – albeit at a slower pace than in recent years. The NAB USD non-rural commodity price index is expected to fall by around 13% in 2016, and a further 8% in 2017, led by  iron ore prices. However, USD appreciation will help to partially offset price declines in AUD terms. NAB forecasts the AUD to bottom at around 69 US cents by early 2017, but stabilise in the mid-70s by late 2018. Overall, these trends suggest the Australian terms of trade will continue its gradual descent, following a brief rise in Q2 2016.

• Despite the Brexit referendum outcome, oil market volatility has been relatively contained by comparison. Given the absence of an OPEC output cap and an expected recovery from supply disruptions, there are significant upside risks to global oil supply in the short term despite falling US production. This suggests upward movements in prices are expected to be relatively constrained  in the near term. We expect oil prices to fluctuate between USD45 to 50 a barrel in Q3 2016, before reaching low the USD 50s/bbl by end-2016 and around USD 60/bbl by end-2017. LNG prices are subdued and likely to remain that way unless there is a substantial jump in the price of oil.

• Iron ore and metallurgical coal prices have risen considerably in recent months – as a credit-fuelled rebound in China’s construction activity has underpinned stronger steel demand. We argue that this rebound is unsustainable (given excess property supply in many locations) and prices should fall on weaker demand – although uncertainty around the duration of this current trend adds upside risk to our forecasts. Iron ore prices are forecast to average USD42.5 a tonne in H2 2016 and USD40 a tonne in calendar year 2017. Hard coking coal contract prices will average USD89 a tonne in H2 2016 and USD84 a tonne in 2017. Thermal coal prices are expected to decline in the next Japanese financial year (from April 2017 ) to USD58 a tonne.

• Base metal prices have been stable to higher since their January lows. Stronger than expected demand from China has supported copper prices while aluminium faces favourable long-term demand from car making and power generation. For nickel, weak prices have delayed rather than cancelled new supply. Zinc had been the best performing base metal, with deficits expected for both 2016 and 2017. The lead market remains well supplied with more production cuts needed.

• On the back of the UK’s “Brexit” vote, we believe that the US Fed is likely to take a more cautious stance in its current monetary tightening cycle. This suggests further upside potential for gold prices in the near term, but we expect gold prices to resume a moderate downward trend in Q4 2016 in line with further US monetary tightening. We now expect gold above USD1300/oz for the rest of Q3, ending 2016 at USD1280/oz before moderating to USD1100/oz by end-2017.

For details, download the full report.

• Commodity Update: Minerals and Energy – July 2016