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For metals and oil, the pain has just begun Add to ...

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Investors who are praying for a bounce back in resource stocks are likely to face frustration in 2014. Most top commodity strategists see a difficult year ahead for the “hole in the ground with a liar on top” sector.

It’s not that the problems facing miners and energy producers are anything new. The S&P/TSX materials index has shed 31 per cent this year, while the U.S. dollar-denominated S&P/GSCI industrial metals benchmark has retreated 1 per cent. But according to prominent strategists, there is still plenty of pain to come.

S&P/GSCI Commodity Index vs EM Industrial Production

(per cent change, year over year)

SOURCE: Scott Barlow/Bloomberg

Commodity prices have fallen in line with emerging markets industrial activity because of the resource-intensive nature of developing economies. In recent years, countries such as China and India have been major consumers of metals and other raw materials as they build new highways, airports and other infrastructure.

But with economic risks rising in China and higher interest rates crippling the outlook for Brazil and India, a rebound in the emerging market economies is unlikely to provide a boost for commodity prices in 2014.

Even if demand from emerging markets turns out to be better than expected, an increased supply of industrial metals such as copper and iron will limit gains in the mining sector. Mr. Deverell estimates that copper production in 2014 will grow at two and a half times the average rate for the previous three years. Iron ore will see a similar supply overhang with production growth almost twice the 2010 to 2013 average.

2014 Production Growth Estimates vs 2010 - 2013 annual average

(per cent change, year over year)

SOURCE: Credit Suisse

Francisco Blanch, global investment strategist at Bank of America, has a similarly bearish outlook. His 2014 commodity outlook carries the headline: “No end in sight to downward commodity price pressures.”

Mr. Blanch shares concerns about oversupply in copper and iron ore but appears even more bearish on energy prices: “We maintain our long-held view that the domestic U.S. crude oil market will remain oversupplied and see meaningful downside risks to [West Texas Intermediate, the benchmark North American crude price].” He expects renewed exports from Iran and Libya to exacerbate the downward pressure on oil prices in 2014.

The U.S. Federal Reserve’s decision to start tapering its quantitative easing policy will also limit returns from commodity sectors next year. Mr. Blanch says Fed stimulus has provided a major boost to commodity prices, so easing back on the bond-buying program will remove a prop from the resource sector.

By forcing the U.S. dollar lower, quantitative easing “created upside pressure on emerging market currencies and in turn emerging market demand for real assets, including commodities. The exact opposite is likely to be true when the Fed removes the liquidity punchbowl,” he writes.

Canadian investors can expect a tough year for commodity stocks but not a catastrophe. Mr. Blanch and Mr. Deverell emphasize that the price outlook for some commodity subsectors – notably platinum and zinc – remain encouraging.

Still, it’s clear that the resource sector overall is going to face challenges. Rather than crossing their fingers and hoping commodity stocks retake market leadership, investors would be better served by looking for new growth areas. Global industrial companies, global health-care providers and businesses that cater to the need for U.S. energy infrastructure are three promising candidates.

Scott Barlow is a contributor to ROB Insight, the business commentary service available to Globe Unlimited subscribers. Read more of his Insights at tgam.ca/ROB-Insight.

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