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Can NR market gain from pRomisiNg fuNdameNtal?In spite of an emerging strong demand-supply fundamental, it is yet to see if the NR market can gain significantly for the short-term in view of certain downside factors such as continued downtrend in crude oil mar-ket, potential strengthening of the US dollar, absence of active financial investors in commodity markets etc.

Surveys and studies increasingly reveal that rubber farmers across major pro-

ducing countries have largely reduced fre-quency of harvesting or left their holdings idle in response to unattractive prices for natural rubber (NR). Consequently, the year 2014 is expected to end with a deficit in the commodity’s global supply. Considering the fact that the period from end-January to May is the leaf-shedding off-season of the supply in major producing countries, the shortfall can only widen during the first half of 2015. In the context of a favourable demand-supply position anticipated at least for the period up to May 2015, what are the expectations on NR prices? Have NR prices already reached the rock-bottom and are gearing-up for a U-turn?

Preliminary estimates available from differ-ent countries suggest that the global demand

for NR would rise by 3.9 per cent to 11.8 million tonnes in 2014 whereas the supply during the year is anticipated to fall by 3.1 per cent to 11.7 million tonnes. As shown in Table 1, year 2014 is likely to end with a deficit by 136,000 tonnes as against the surplus of 687,000 tonnes generated in the previous year.

Fundamentals gain strengthIt is true that the quantity of 687,000 tonnes of surplus generated in the previous year will partly defuse the positive effect of the deficit expected for 2014. However, the period from end-January to May is the ‘wintering’ or leaf-shedding off-season for NR supply in major producing coun-tries. The supply considerably falls every year coincident with the leaf-shedding season. Therefore, the demand-supply position is likely to stay favourable to NR

prices at least for the period up to May 2015.

Coming to the demand side, a major factor that clouds expectations on a faster growth is the slowing manufacturing activity in Chi-na. However, the negative effect of the Chi-na-factor is expected to be offset, at least partly, by the faster demand growth antici-pated for Vietnam, Thailand, Indonesia and India. Thailand, Vietnam and Indonesia have already initiated specific measures aimed at boosting domestic manufacturing of rubber products. The measures include investment promotions in the form of tax incentives for setting up rubber-based manufacturing units.

In November 2014, Thailand’s Board of In-vestments approved investments for new eco-car projects by Toyota Motors, Honda Automobiles, Suzuki Motors and ASIC Mo-tors having the total capacity to produce 410,000 passenger cars per annum. The Board also approved tax incentives for fac-tories setting up in the country’s five Spe-cial Economic Zones. Besides, the cabinet has approved a package of tax incentives for companies that set up international headquarters in Thailand. It is striking to note in this context that 10 Chinese rubber-products manufacturing companies, at the initiative of the Chinese Government, have completed surveys in Thailand, Indonesia and Myanmar in search of suitable sites for the establishment of plants. Bridgestone, in October 2014, opened a new auto-tyre plant in Vietnam, having the capacity to produce 10,000 tyres per day, for catering to the demand from North America, Eu-rope and Japan. The plant’s capacity will be expanded to produce 49,000 tyres per day by 2016.

Growing prominence of Southeast Asia As China gradually loses its advantages as a low-cost region, multinational companies increasingly consider the South-east nations as preferred locations for setting up new manufacturing bases. The influx of foreign investments from China, South Korea and Japan are expected to help Cambodia, Laos, Myanmar and Vietnam to reinforce labour competence and manufacturing quality. These developments provide strong signals on accelerated growth in rubber-based man-ufacturing in major NR-producing countries. Late 1990s had witnessed shifting of the

The writer is Deputy Director, Rubber Board of India. The views expressed in the article need not represent those of the organization

Jom Jacob

RSS-4 sheets, the small-growers’ livelihood

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world’s rubber-based manufacturing from the West to the East with China as the new gravity centre of the global demand for rub-ber. As China gradually loses its competitive advantages in manufacturing, a new process is taking shape within Asia, with a growing significance for the Southeast Asian coun-tries. So, for the accelerated growth in NR demand, it is not a pre-requisite that China’s demand growth should come back to its ear-lier two-digit path.

According to conventional theory of eco-nomics, NR prices should take a U-turn from the end of 2014 in response to the anticipat-ed tight demand-supply position. But, the conventional economic theory is based on the assumption of “ceteris paribus” which means “other things remain the same”. NR market is influenced by a host of “other things” which are referred to as non-funda-mental factors. They include market senti-ments arising from potential competition from synthetic substitutes on account of dynamics in crude oil market and exchange rate fluctuations. Moreover, speculative in-vestors and fund managers often influence NR prices through the positions they take in commodity futures in response to prevail-ing economic and geopolitical situations. As NR is not immune to “financialization of commodity markets”, its prices can be strongly influenced by the general trends in global commodity markets. The dominant influence of these sets of non-fundamen-tal factors may even nullify the effect of a

strong demand-supply fundamental.

What is attempted at here is a brief review of NR prices across key markets and a gaze into the short-term future by focussing on the potential role of non-fundamental fac-tors in setting the emerging trends.

Review of NR pricesTable 2 presents the dynamics of NR pric-es since 2010 for SMR-20 (Kuala Lumpur), RSS-3 (Bangkok), RSS-4 (Kottayam) and Latex-60% (Kuala Lumpur). The table gives the annual average, annual minimum and annual maximum for the four markets. Pric-es realized on December 12, 2014, (i.e., the latest price) are also given. Strikingly, the current rates are 50 to 65% lower compared to the annual average prices during 2010. Compared to the annual average rates in 2011, the current rates are 60 to 70% lower. In other words, NR prices currently rule at a third of the average rates realized three years ago. It is noteworthy that RSS-3 had peaked US$ 649.7 per 100 kg at one point of time (February 21) in 2011 whereas the cor-responding rate on December 12, 2014, was US$155.2 per 100 kg.

The following sub-sections separately anal-yse the influence of key non-fundamental factors on NR prices and their potential role in setting the trends in the short-term future.

Crude oil trends & speculation on substitutionSpeculative investors generally consider

synthetic rubber (SR) as a substitute for NR. As SR is a petroleum-derived product, devel-opments in crude petroleum oil market have a profound influence on NR prices. Specula-tion on possible substitution with SR makes NR prices sensitive to crude oil trends. Al-though technical considerations often limit the scope for substitution between SR and NR, the former is generally considered as a substitute for the latter in several applica-tions. However, rather than actual substitu-tion, it is through speculation on possible substitution that crude oil prices influence the NR market. Speculative investors often consider crude oil trends in taking invest-ment positions in NR futures.

Among various NR futures, TOCOM RSS-3

is considered as a global benchmark on ac-count of its dominant influence in setting the trends in the global physical market for NR. The trends in TOCOM RSS-3 futures often get transmitted into physical rubber market. Figure 1 is the super-imposition of physical RSS-3 prices (Bangkok) on Europe Brent crude oil prices for the period from August 1 to December 12, 2014.

As is evident from the graph, physical prices of RSS-3 have generally tracked the down-trend in crude oil prices with very few ex-ceptions. Due to the presence of other fac-tors influencing NR market, the prices are not expected to move perfectly in accor-dance with those of crude oil. During the period from August 1 to December 12, 2014

Speculative investors generally consider synthetic rubber (SR) as a substitute for NR. As SR is a petroleum-derived product, developments in crude petro-leum oil market have a profound influence on NR prices. Specula-tion on possible substitution with SR makes NR prices sensitive to crude oil trends. Although techni-cal considerations often limit the scope for substitution between SR and NR, the former is general-ly considered as a substitute for the latter in several applications

TSR kept for packaging & transportation

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Table 1: Global demand-supply position

Quantity (‘000 tonnes) Annual growth (%)

2012 Actual

2013 Actual

2014 Likely

2012 Actual

2013 Actual

2014 Likely

Consumption 11,008 11,355 11,800 0.1 3.2 3.9

Production 11,603 12,042 11,664 3.3 3.8 -3.1

Gap 595

(Surplus)

687 (Surplus)

-136 (Deficit)

Note: Figures for 2014 are the author’s independent estimates.

Brent crude oil market fell by 40% (from US$ 103.45/barrel to US$ 61.85/barrel) and physical RSS-3 prices registered a 20% fall (from US$ 198.97/100 kg to US$ 1551.5/100 kg) during the same period.

Looking ahead, OPEC Member-Nations are unlikely to reach a consensus on cutting crude oil output. OPEC currently accounts for only a third of the global crude oil out-put. A section of OPEC Members are of the view that curtailment of output would re-sult in further loss of OPEC’s market share to North American shale producers. Unless OPEC curtails the output, crude oil prices

are anticipated to continue the downtrend because of the US shale boom and slower economic growth anticipated for China and Europe. This implies that crude oil is likely to continue weighing on NR prices at least for a few more months.

Exchange rate regime is another non-funda-mental factor influencing NR prices.

Influence of exchange ratesNR is an internationally traded commodity. Of the total quantity of 12.04 million tonnes globally produced during 2013, an estimated 80.9% was sold in the export market. The three countries — Thailand, Indonesia and Malaysia -- accounted for 79.6% of the global exports in 2013. The trade generally takes place in terms of the US dollar. Therefore, a depreciation of the local currency (i.e., Thai baht, Indonesian rupiah and Malaysian ringgit) enables exporters to offer NR at a

lower price quoted in the US dollar. In other words, NR exporters become price-compet-itive whenever the local currency depreci-ates against the dollar. As exporters widely adopt this pricing strategy, NR prices quoted in terms of the dollar tend to fall during the depreciating phase of local currency.

The US Federal Reserve on October 29, 2014 ended its monthly bond purchase pro-gramme, known as “quantitative easing”, that was put in place in 2008 to keep market interest rates low and thereby to spur lend-ing and investment. The US dollar surged higher after the Federal Reserve signalled confidence on the country’s economic re-covery while investors started betting on an increase in the US interest rate sooner than previously expected. Although the Federal Reserve did not change its benchmark in-terest rates, the renewed confidence in the US economy and speculation on potential increase in interest rates attracted global funds to the US. This has been reflected in the dollar’s sharp appreciation since the last week of August 2014. Consequently, the currencies of major NR exporting countries started depreciating against the dollar and the downtrend continues. Apart from this factor, the downswing in crude oil prices has also contributed to the weakening of the Southeast Asian currencies. This is because of the fact that the falling oil prices and the resultant erosion in purchasing power of oil-dependent economies have affected South-east Asia’s merchandise exports to these countries.

Although Thai baht depreciated only by two per cent, Indonesian rupiah and Malaysian ringgit lost strength respectively by six per cent and eight percent against the dollar during the period under review. An eight per cent weakening in the Malaysian ringgit im-plies that NR exporters in the country have realized that much space for bringing down the export prices of NR quoted in dollar terms. For example, even if NR earlier ex-ported at US$160/100 kg is now offered at an eight per cent reduced rate of US$147.2/100 kg, the exporter’s realization in terms of Malaysian ringgit remains the same. When NR exporters in Malaysia adopt this pricing strategy, their counterparts in other export-ing countries are left with no option but to bring down the offer rates to those of Malay-sia’s. Ultimately, this brings down the prices in the global market.

Figure 2 shows the movements of the Ma-laysian ringgit vis-a-vis prices of SMR-20 in Kuala Lumpur market during the peri-od from August 1 to December 12, 2014. Exchange rates are represented in terms of the US$ equivalent to 100 ringgit. Evi-dently, SMR-20 prices have tracked the sharp depreciation in Malaysian ringgit during the entire period with very few exceptions.

Looking ahead, the benchmark interest rates in the US are likely to be raised in the immediate future from the prevailing near-zero rates. Continuing speculation on higher US interest rates by financial inves-tors is expected to help the dollar to gain further strength. This implies that the cur-rencies of major NR exporting countries are likely to continue depreciating against the dollar at least for a few more months and NR prices are expected to track the downtrend.

Another dimension of the influence of

exchange rate regime is with reference to the Japanese yen’s sharp fall since mid-Oc-tober. It is in terms of the Japanese yen that Tokyo Commodity Exchange (TOCOM) trades RSS-3 futures. During the short peri-od from October 16 to December 12, 2014, the Japanese currency lost strength against the dollar by around 10%. The depreciated yen has made TOCOM RSS-3 futures attrac-tive to speculative investors from overseas. For example, on October 16, 2014, an over-seas investor had to spend US$172 for buy-ing 100 kg of RSS-3 futures from TOCOM (At the rate of 182.50 yen/kg which was the TOCOM closing price on the day). If the yen depreciates by 10%, he needs to spend only US$154.80 for buying the same quan-tity of RSS-3 futures. The resultant higher demand from speculative overseas inves-

tors has helped RSS-3 futures to rise from October 16 through mid-November. How-ever, RSS-3 futures could not sustain the uptrend beyond mid-November because the sharp fall in crude oil prices weighed down investor sentiments. Figure 3 illus-trates this point.

It is striking to note that the uptrend in RSS-3 futures in TOCOM has been driven largely by the yen’s sharp depreciation and not on

NR is an internationally traded commodity. Of the total quan-tity of 12.04 million tonnes globally produced during 2013, an estimated 80.9% was sold in the export market. The three countries -- Thai-land, Indonesia and Malaysia -- accounted for 79.6% of the global exports in 2013. The trade generally takes place in terms of the US dollar. There-fore, a depreciation of the local currency (i.e., Thai baht, Indonesian rupiah and Malay-sian ringgit) enables exporters to offer NR at a lower price quoted in the US dollar

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Table 2: Annual average, minimum and maximum prices from 2010 onwards (US$ per 100 kg)

2010 2011 2012 2013 Current price (On 12 Dec 2014)

SMR-20 Kuala Lumpur

Average 333.3 446.6 312.4 249.8

145.1Minimum 272.1 309.2 242.7 215.4

Maximum 488.7 (27 Dec)

569.9 (17 Feb)

378.8 (26 Jan)

312.6 (6 Feb)

RSS-3 Bangkok

Average 364.5 485.1 341.4 279.3

155.2Minimum 289.8 324.5 273.7 245.4

Maximum 496.9 (30 Dec)

649.7 (21 Feb)

415.5 (8 Jan)

340.2 (11 Jan)

RSS-4 Kottayam

Average 370.3 465.6 346.4 288.9

181.8Minimum 284.0 362.4 288.7 243.2

Maximum 460.9 (24 Dec)

545.0 (11 Apr)

396.5 (3 Apr)

331.0 (27 Jul)

Latex 60% Kuala Lumpur

Average 297.3 369.1 216.4 180.8

101.6Minimum 210.2 205.8 169.7 158.7

Maximum 406.2 (29 Dec)

460.5 (20 Apr)

266.1 (24 Feb)

209.0 (15 Jan)

Note: (i) Average, minimum and maximum are based on the daily prices reported by ANRPC; (ii) Given in the parenthesis are the dates on which the maximum price during the year was realized; (iii) For Latex 60%, the prices refer to wet weight.

account of sentiments in the physical mar-ket. In fact, the physical market has been weighed down by dominant influence of other factors which include the sharp fall in crude oil prices and deprecation in ex-porting countries’ currencies. Therefore, physical prices and futures prices which had moved closely in tandem until mid-

October, have diverged thereafter (Figure 4).

The divergent trends taken by futures and physical suggest that the yen is unlikely to have a profound influence in determining the trends in physical prices of NR in the short-term future.

Although rubber prices are influenced by factors specific to the sector, they tend to track the general trends in the entire com-modity markets due to the influence of spec-ulative investments and funds.

Speculative investments and fundsFinancial investors increasingly consider commodities as a distinct asset class. With the financialization of commodity markets, speculative investors and fund managers assume a greater role in deter-mining the trends in global commodity prices. They often take investment posi-tions in response to changing economic outlook and geopolitical developments and thereby act as a transmission belt for the commodity prices to be immediately influenced by key developments. NR is no exception to the financialization of commodity markets. Therefore, its prices are likely to be influenced by the general trends in global commodity prices

Figure 5 shows the average monthly pri-ces of SMR-20, in US$ per 100 kg, in Kuala Lumpur vis-a-vis monthly price indices with the base year 2005 reported by the IMF for “All Commodities” and “Crude Oil” for the period from January to November

2014. It is evident that global commodity prices have edged lower since July 2014 onwards and NR prices have followed suit. The conclusion is that current phase of downswing in NR prices is greatly influ-enced by the outflow of funds by financial investors.

The Commodity Outlook released by the IMF in October 2014 anticipates that price indices of “All commodities” would con-tinue the falling trend through 2019. The index is expected to fall from 182.9 in 2013 to 178.7 in 2014 and further to 172.3 in 2015. In anticipation of potential further fall in commodity prices, speculative investors and hedge managers are likely to stay away from commodities for betting on alternative avenues having better growth prospects. Moreover, the anticipated strengthening of the US dollar can make Asian commodi-ties less attractive to speculative financial investors. As a result, commodity markets are unlikely to get support from financial investors. This general trend in global com-modities is expected to manifest in NR mar-ket as well.

Can NR market gain?The anticipated scenario of favourable de-

mand-supply fundamental is expected to support global NR prices until May 2015. But, a set of non-fundamental factors clouds the expectations for the recovery. These include:

i) An anticipated continuation of the pre-vailing downtrend in crude oil market

ii) Potential strengthening of the US dol-lar and the resultant weakening of NR ex-porting countries’ currencies

iii) Lack of active presence of financial investors in commodity markets.

In view of these downside risk factors, the emerging strong demand-supply fun-damental need not be fully translated into a corresponding increase in NR prices. Even if the prices recover for the period up to May 2015, the magnitude of recovery will be marginal. Moreover, any marked recovery in NR prices will increase the supply in the short-run be-cause price-induced farmers are likely to adopt intensive harvesting and other short-term measures for exploiting the maximum yield.

The Commodity Outlook re-leased by the IMF in October 2014 anticipates that price indices of “All commodities” would continue the falling trend through 2019. The index is expected to fall from 182.9 in 2013 to 178.7 in 2014 and fur-ther to 172.3 in 2015. In antici-pation of potential further fall in commodity prices, speculative investors and hedge manag-ers are likely to stay away from commodities for betting on alternative avenues having bet-ter growth prospects