• Drought in U.S. Midwest Propelling Grain Prices to Record Highs
• Debate Steps Up on an Energy Policy for Canada

TORONTO, July 26, 2012 /CNW/ - Scotiabank's Commodity Price Index dropped by a sharp 3.7 per cent month over month (m/m) in June, the seventh consecutive monthly decline. The All Items Index fell 19.0 per cent below the near-term high in April 2011 - just prior to the advent of international concern over excessive Euro Zone sovereign debt - though the correction remains less than half the 46 per cent slide in the second half of 2008.

"A sharp loss of business confidence worldwide - linked to Euro Zone financial strains and slowing world growth - led investors to shift from riskier assets such as commodities and equities into the security and liquidity of U.S. Treasury securities," said Patricia Mohr, Vice-President, Economics and Commodity Market Specialist, at Scotiabank. "Oil prices - which often trade on global growth expectations rather than industry developments - were particularly dampened by poor confidence."

Concern over a slowdown in China - with Gross Domestic Product (GDP) decelerating to 7.6 per cent in the second quarter of 2012 from 8.1 per cent in the first quarter and 9.3 per cent in 2011 - also took a toll - particularly on industrial metal prices.

However, the decline in Scotiabank's Commodity Price Index in June may represent a near-term bottom, with commodity prices rallying back in July.  Several positive proposals at the June 28-29, 2012 European Union Summit to shore up Euro Zone financial markets temporarily lifted sentiment for riskier assets, though uncertainty remains. China has also recently shifted to a more aggressive pro-growth monetary and fiscal policy.

The Agricultural Index edged up by 0.3 per cent m/m in June and promises to strengthen further in July. U.S. corn (a feed grain and sweetener) and soybean prices (an oil seed) soared to all-time record highs in mid-July amid the driest and hottest weather conditions in the U.S. Midwest since the '80s, when U.S. President Ronald Reagan was in office. These developments will have major implications for international food prices later this year, with the U.S. by far the world's top exporter of corn (normally accounting for more than 50 per cent and, even this year, 40 per cent of world trade).

"Record U.S. soybean prices have pushed up canola at the Port of Vancouver to a record high - Cdn$671 per tonne to date in July," said Ms. Mohr. "With relatively favourable growing conditions on the Canadian Prairies this year, canola will likely emerge as a $10 billion crop alongside record output and prices in 2012-13. Though dry conditions will constrain Southern Ontario's corn and soybean crops, Canada's overall grain and oilseed revenue could also be a record this autumn."

The Scotiabank Oil and Gas Index retreated sharply in June (-9.0 per cent m/m). While the discount on both light, sweet (-US$3.72) and Western Canadian Select (WCS) heavy crude oil (-US$16.03) relative to West Texas Intermediate (WTI).oil narrowed in June, actual prices fell to US$78 per barrel and US$66 respectively, as international oil prices lost ground.

However, Brent and WTI oil prices have rallied back to US$104 and US$89 respectively in mid-July, with geopolitical tensions ratcheting up in the Middle East.  The European Union imposed  a full embargo on Iranian oil imports on July 1, 2012 and the United States implemented sanctions on June 28, 2012.

Debate is stepping up on a new energy policy for Canada. On the proposed Northern Gateway Pipeline, the B.C. provincial government has set out five prerequisites for support of heavy oil pipeline development across B.C. and tanker traffic on the coast. Western Canada's oil output is expected to grow by about one million barrels per day (mb/d) from 2.7 mb/d in 2011 to 3.6-3.8 mb/d by 2015 (from oil sands production as well as tight oil and conventional light and heavy oil).

"In my view, developing adequate transportation infrastructure, in a timely way, to tap the fast growing markets of Asia is vital for Canada's oil patch and the Canadian economy," said Ms. Mohr.

Metals and Minerals also dropped by 1.2 per cent m/m in June, with broad-based declines in base metals, iron ore, steel additives (cobalt and molybdenum) and uranium - only partly offset by an edging up in gold prices.

On a more positive note, tightness in the global market for premium-grade hard coking coal will boost contract prices for Western Canada to a lucrative US$225 per tonne (FOB Vancouver) in the July-to-September quarter - up seven per cent from US$211 in the quarter just ended. World steel production has only edged up this year (+0.8 per cent), pointing to limited growth in underlying coking coal demand. However, force majeure by the Billiton Mitsubishi Alliance (BMA) mines in Queensland from April to mid-July has substantially tightened supplies.

Gold prices, at US$1,601 per ounce in late July, have held up well, but have failed to advance this year. Traders are awaiting further 'quantitative easing' by the U.S. Federal Reserve or the European Central Bank (ECB).

The Forest Products Index was largely flat in June, though lumber and Oriented Strand Board (OSB) prices remain well above year-ago levels.  A significant strengthening in lumber prices is expected in 2013, as a slowly improving U.S. housing market hits a wall of limited North American supply.

Scotiabank Economics provides clients with in-depth research into the factors shaping the outlook for Canada and the global economy, including macroeconomic developments, currency and capital market trends, commodity and industry performance, as well as monetary, fiscal and public policy issues.

SOURCE: Scotiabank