The second wave of COVID-19 has yet to stall a commodities run, but until vaccinations and recently announced fiscal stimulus in the US ramp up it continues to put the global economy and commodities at risk. Uncertain demand and oversupply in the global markets will likely soften oil’s price near term but it’s unlikely the US reversal on the Keystone XL pipeline will affect it. Meanwhile, robust US homebuilding underpinned by a pandemic-inspired preference for single-family homes is keeping lumber prices elevated. And various factors are keeping the USD in a narrow range, while the CAD remains a middle-of-the-pack performer.
Scotiabank analysts and economists weigh in on what the pandemic means for commodity prices, equities and currency rates.
Commodities
- The second wave of COVID-19 hasn’t stalled commodities momentum, yet. However, the pandemic remains the principal risk to the global economy and to commodity pricing, causing us to lower our economic forecast for the first quarter of 2021. Better outcomes are expected beyond Q1 as more people get vaccinated, resulting in economies reopening. Fiscal stimulus measures recently announced by US President Biden should also ramp up as 2021 progresses.
- Recent oil price momentum could ease in the current quarter, given a softer demand outlook and OPEC+ uncertainty. Assuming some near-term softness that reflects an uncertain demand outlook, WTI should average about 46 USD/bbl in Q1 2021 versus the 52 to 53 USD/bbl range seen in the past two weeks. Given recent price gains, OPEC+ quota compliance will likely be tested in the coming months, which could add to already very oversupplied global market balances. In the first half of the year, the end of Alberta’s curtailment program, which is increasing oil production in the province, will likely contribute to a wider WCS discount to WTI. However, the province’s crude output had already registered a year-over-year increase in November as producers responded to recent price gains.
- The Keystone XL (KXL) pipeline’s demise should not on its own alter long-run supply-demand balances or pricing for Western Canadian oil, but it is clearly negative for local employment and investment activity. While pipelines serve to increase the capacity for Western Canadian crude to be transported to refineries in the US Gulf Coast, we argued before the pandemic that only two of the three major projects— KXL, Line 3, Trans Mountain Extension (TMX) — were needed to align supply and demand of crude volumes by the end of this decade. Recent oil output projections from the Canadian Energy Regulator appear to confirm that view.
- Lumber prices remain elevated, supported by robust US homebuilding. A preference for single-family homes in the US and Canada, requiring more lumber than multi-unit homes, and rock-bottom mortgage rates will continue to drive demand. The 1.669 million seasonally adjusted annual rate for US housing starts reported last month was the highest in any month since 2006 and resulted in the strongest annual average since that year, underscoring the housing market’s resilience in the face of a severe economic downturn. However, supply is likely to be limited by ongoing cutting restrictions in British Columbia. The Random Lengths North American Framing Lumber Composite Index is hovering around 900 USD, more than 50% higher than levels a year ago. We anticipate an average WSPF price near 550 USD/Mfbm for 2021.
— Marc Desormeaux, Senior Economist
Equities
- Seasonality headwinds offset sustained recovery. Bottom-up consensus is pegging TSX Q4/20 EPS at C$238, suggesting the earnings recovery will take a breather (-0.9% quarter-over-quarter) after a record +55% sequential improvement in Q3/20. While still down 11% year-over-year, Q4/20 is expected to be the last quarter to suffer year-over-year EPS contraction; earnings growth should markedly improve starting in Q1/21. For now, seasonality headwinds and mixed commodity prices are clashing with improving fundamentals. On the negative side, Q4s are usually weaker than other quarters (-1.9% according to our model), while heavy crude prices were flattish and gold down. On the flip side, most Canadian macro indicators and base metal prices exceeded sell-side estimates throughout the quarter.
- On a 12-month trailing basis, TSX EPS are seen troughing in Q4/20 at C$767 (-3.6% q/q, -28% y/y). The year-over-year comparison is done with the all-time high of C$1,063 hit in Q4/19. Consensus expects to exceed that high watermark by Q1/22, as 2021 should be a very strong recovery year for most sectors.
- Top line (SPS) could hit a four-year low. TSX quarterly revenues may hit a four-year low in Q4/20 as revenue erosion continues following a record-setting 2019. However, we would warn that lack of consensus estimates among insurers and diversified financials is severely skewing the picture downward. Q2/20 and Q3/20, which faced the same issues, saw actual SPS beat consensus by 16% and 11%, respectively.
- Consensus appears conservative. Financials, technology, and industrials could beat, but energy could disappoint. We believe sell-side estimates have lagged the rapid recovery in underlying macro conditions in most sectors. Our opinion is reinforced by our sector regression models, which indicate consensus is mostly conservative in industrials (strong PMI/train carloads rebound) and financials (lower PCL, high capital market and housing market activity). Technology also seems to have a low bar to beat, with tech companies enjoying median beats of 20%+ in each of 2020’s quarters. Meanwhile, flattish oil prices (WTI +5% quarter-over-quarter, Syncrude +1%, WCS +1%) imply that energy’s 54% quarter-over-quarter EPS growth forecast may be ambitious, although there definitely is strong operating leverage in the sector. In materials, base metals miners and chemicals could surprise to the upside, although gold miners and lumber may offset this.
- Sectors. Six out of 11 sectors should still sport year-over-year EPS contraction in Q4/20, with seasonality impacting several sectors. Cyclicals’ earnings should continue to recover much faster than defensives.
— Hugo Ste-Marie, Director Portfolio & Quantitative Strategy; Jean-Michel Gauthier, Associate Director, Portfolio & Quantitative Strategy; and Simone Arel, Research Associate, Global Equity Research
Foreign Exchange
- The USD held in a relatively narrow range this week just as it has since the start of 2021, alongside a cautious mood in markets that await the end of lockdowns. The risk mood in markets was also troubled as equities experienced heightened volatility as investors fret over the overvaluation of a handful of equities targeted by retail investors. The delay in the passage of a new stimulus bill in the US has also cooled bullish expectations in markets, which we expect should improve as vaccination rates accelerate. At its mid-week policy announcement, the Federal Reserve did little to comfort markets as it offered only a mixed outlook of the economy.
- The CAD was a middle-of-the pack performer on the week, holding mostly within the 1.26-1.28 USDCAD range it has been caught in since the year began. However, the CAD touched its 50-day moving average for the first time since early-November, as USD-selling pressure seemingly eases (with USD-positive seasonal factors a possible driver) and crude oil prices weaken slightly from pandemic-period highs. Canada’s relatively slow pace of vaccinations also poses a near-term headwind for the CAD, with only 2.3 vaccines doses administered per 100 people, compared to 7.5 per 100 in the US.
- On the other side of the picture, the UK’s 11 per 100 people vaccination rate has helped the GBP reach its highest level against the USD since 2018, extending a strong bullish trend above 1.37 since early November.
- A series of key data releases in the week ahead are set to influence the dollar mood, concluding with the release on Friday of US and Canadian January employment data. Economists expect another decline in jobs amid virus restrictions. Markets should continue to monitor developments in the roll-out of vaccines and negotiations around additional spending in the US.
— Shaun Osborne, Managing Director, Chief FX Strategist, and Juan Manuel Herrera, FX Strategist
For Scotiabank, Global Banking and Markets Research Analyst Standards and Disclosure Policies, please visit www.gbm.scotiabank.com/disclosures.
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