The commodity outlook for 2012

By Chris Tedder, research analyst, Forex.com

A hard landing in China is the biggest threat to commodity markets in our opinion, as they are the source of much commodity demand. This demand has continued to increase during 2011, whilst OECD economies have seen demand decline. Nonetheless, the country is currently facing some pressure from Europe through its export channel, where it faces the risk of growth being severely hampered by a substantial drop in export demand.

China's share of the commodity market is substantial, the country accounts for 40% of industrial metal demand, 20% of the demand for grain and around 11% of global oil demand. Furthermore, China has accounted for two-thirds of growth in commodity demand during 2011, and 50% in 2010. This means that commodity prices are very exposed to a shift in demand from Beijing, especially industrial metals like copper, with over 60% in growth of demand for the metals coming from China.

We also have to look at the effect of the slowing property market in China. Government measures to halt the property bubble and the decreasing amount of new infrastructure programs could weigh on demand for copper and steel. However, we have seen China's imports of iron ore come off the lows we saw a few months ago, and they are climbing back towards 2010 levels.

Oil prices to reflect effects of any political, security events

In Europe, the threat of a prolonged recession might put a cap on any potential gains for commodities. The EU is the largest economic zone in the world and the leading trading partner of China and the US, and if the region falls into a period of negative growth, and we think it will, then export markets throughout Asia will suffer. Furthermore, if this eventuates it threatens to drag the US and the rest of the world in to a global recession, but we do not think this is likely. The US is clearly suffering, yet we expect it to grow slowly throughout 2012.

This should provide a boost to oil prices, as the US accounts for a quarter of global demand. Nevertheless, the risk of renewed violence in the Middle East could weigh on its price. Any contraction of supply usually leads to a hike in prices. We could also see an effect on the price from the anticipated withdrawal of US troops from Iraq, if Iraqi security forces fail to maintain order, and from heightened political tension in Iran.

Opec, the oil producer cartel, said that it would limit production in the first six months of next year to 30 million barrels per day. This is a reminder that when it comes to predicting oil prices for next year you cannot rule out political risk.

Overall, we do not anticipate a global recession, and whilst we are predicting a recession for Europe, we do not think it will lead to a prolonged period of negative growth for the region, and therefore we can see some potential upside for certain commodities. However, any potential upside, at least in the short-term, will likely be limited by negative investor sentiment stemming from Europe.