Gold to Cotton Seen Losing by SocGen With Brent at $70

Gold and cotton are among commodities that will drop the most if Brent crude extends its collapse to $70 a barrel, according to Societe Generale SA.

Bullion would slide by 5 percent in the three months after oil falls to the bank’s “bear case” scenario for prices, analysts including Michael Haigh, the New York-based head of commodities research, wrote in a report e-mailed today. Cotton could lose almost 6.8 percent over a year while coal may decline about 3 percent before rebounding, it forecast.

Brent’s 30 percent slump since June to below $80 a barrel roiled markets around the world, from Nigeria’s naira to Venezuelan bonds. While cheaper crude would ultimately boost global economic growth and drive raw material prices higher as demand picks up, the shorter-term effect on other commodities is mixed, according to Societe Generale.

“The interconnections of the rest of the commodity complex to oil prices are unique and varying in importance,” the analysts wrote. “It is clear that the ‘input’ costs of oil should lower the cost of production of some commodities and hence make the floor of those prices lower.”

Brent Crude

Brent for January settlement was at $79.84 a barrel on the ICE Futures Europe exchange today, taking its loss this year to 28 percent. The benchmark for more than half the world’s oil dropped to a four-year low of $76.76 on Nov. 14. West Texas Intermediate, the U.S. marker, was at $75.94 today, down 23 percent in 2014.

Under the bank’s “base case” scenario, Brent will recover to average $90 a barrel in 2015 and 2016 as Saudi Arabia succeeds in persuading other members of the Organization of Petroleum Exporting Countries to agree to a “significant output cut” when the group meets in Vienna on Nov. 27. WTI crude will average $82 in 2015 and $81 in 2016, it said.

Should OPEC refrain from cutting production and leave the market to re-balance demand and supply, then Brent may drop as low at $70 a barrel in 2015 and 2016, and WTI to $65, the bank estimated.

A slide in oil to that level will slow inflation and reduce the incentive to hold gold as a hedge against rising prices, according to Societe Generale. Bullion, at about $1,198 an ounce on the Comex in New York today, would decline 5 percent within the first three months before stabilizing about 2 percent lower as demand picks up, the bank said.

Bearish Pressure

“The lower inflation will add bearish pressure to our already bearish outlook,” the bank said. “We expect gold prices to move toward $1,000 and the lower oil prices should add even greater conviction to that view.”

Corn is the agricultural commodity that’s most directly affected by falling oil prices as cheaper energy lowers the cost of production, helps increase margins and stimulates more output, the bank said. The grain, which is down 9 percent this year at $3.8275 a bushel on the Chicago Board of Trade, may slide 3 percent with oil at $70, it said. Cotton, which has the largest per-acre energy costs, would drop 6.8 percent.

Bearish bets on gold and U.K. natural gas will benefit if oil continues declining, Societe Generale said. The bank also recommended a put options strategy on Brent to profit from future losses.

The short-term impact on industrial metals would be limited, according to the bank. While power accounts for 40 percent of production costs of aluminum, the most energy-intensive of the base metals, thermal coal is the predominant power-source.

‘Minimal’ Effect

The bank projects a “minimal” effect on coal as long as the reason for the drop in oil is “structurally inherent to oil’s demand and supply and is not the outcome of a macroeconomic event,” according to the report.

“Should oil prices drop to $70, coal prices will also drop, reaching their maximum decrease of about 3 percent with a four-month lag with respect to the event,” Paolo Coghe, the bank’s European power analyst, wrote in the report. Thermal coal at the Australian port of Newcastle, the benchmark price for Asia, slid 27 percent this year to $62.10 a metric ton as of Nov. 14, according to data from IHS McCloskey.

Natural Gas

The effect of lower oil on gas is more direct as prices are often linked to crude, SocGen said. Brent at $70 would mean the price of liquefied natural gas in Asia, where about 75 percent of long-term contracts are indexed to oil, drops to $10.90 per million British thermal units, compared with $13.90 per million Btu with Brent at $90, according to the bank. Russia’s OAO Gazprom would sell supplies to Europe at about $6.70 per million Btu, down from $8.60 per million Btu with Brent at $90, SocGen estimates.

The bank’s bear-case scenario for WTI could drive up U.S. natural gas prices as it prompts a slow-down in drilling, curbing production growth. It may also encourage producers to drill more gas rigs, in preference over oil, which would be bearish for prices, it said.

Societe Generale estimates that a $20 a barrel decline in oil prices adds 0.26 percentage points to global gross domestic product in the first year after the slide.

“What is common across all commodities is the rather circular element of increased demand for commodities arising from increased GDP (with a lag) resulting from lower oil prices,” the analysts wrote.

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(Corrects spelling of analyst’s name in 14th paragraph in story published on Nov. 24.)
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