“Just when investors thought it might be time for a summer lull” financial markets have a new drama. With a Greek exit from the eurozone off the table – for now, at least – the fall in commodity prices has moved centre stage, with the pace quickening in the past few days.
The Bloomberg Commodity index, which tracks 22 raw materials, has fallen by around 30% this year alone, and has now reached its lowest level since 2002. Prices have slumped across the board. Brent crude has fallen to a four-month trough around $53 a barrel. Gold is at a five-year low. Copper hasn’t been this cheap since the depths of the global crisis. Unusually healthy American harvests are depressing grain prices.
Strong supply and weak demand
On the demand side, China is the main worry. Its slowdown has unnerved commodity investors for some time, as it is the main consumer of base metals. It accounts for almost half of global copper demand and 70% of iron-ore consumption. Annual growth has slowed to around 7%, the lowest since 1990, as the government attempts to engineer a reduction in the breakneck pace of investment – especially in the property market – in favour of greater consumption, which is less commodity-intensive.
So commodity demand is in a structural slowdown. On top of this, while official GDP data “continue to helpfully meet Beijing’s targets”, as The Wall Street Journal’s Liam Denning puts it, other numbers point downwards. Early this week, for instance, an index tracking the manufacturing sector slid to a 15-month low. The sector has been shrinking for five months now.
In recent weeks, huge losses on the Chinese stockmarket (albeit following a very rapid run-up), and the potential ramifications for the economy, have compounded jitters about an unexpectedly sharp slowdown. The Greek crisis has also fuelled worry over a further slowdown in Europe.
Meanwhile, most commodity markets look well supplied, especially the oil market. Oil cartel Opec is still pumping record amounts, while the number of oil drilling rigs recently rose by its highest weekly total in a year. So it seems that “shale producers are finding ways to weather low prices”, say Anjli Raval and David Sheppard in the Financial Times. There is also plenty of industrial metal around, particularly iron ore. Finally, a US dollar bull market has always been bad news for assets priced in the American currency. With markets expecting a rise in US interest rates, the dollar’s strength seems likely to continue for now.
Is the bottom in sight?
“It would be dangerous to suggest we have seen a bottom,” says Nic Brown of Natixis. Market sentiment has become more bearish in the past few days, judging by trading positions in the futures markets. Speculators hold fewer “long” positions on crude oil than at any time in the past five years, while they are actively “shorting” gold for the first time in a decade.
Of course, this could be a contrarian signal. “The pendulum has… swung too far towards pessimism,” reckons Capital Economics. Overall sentiment has rarely, if ever, been more negative, yet the backdrop isn’t as bad as all that. As far as China is concerned, recent stimulus has yet to kick in, while few Chinese private investors actually own shares, so the market slump shouldn’t hit the economy hard. The likelihood is that global economic activity hit bottom in the first quarter, so demand should improve. Meanwhile, the supply of some base metals is beginning to tighten.
It’s also worth noting that major mining companies haven’t offered such high yields since the 1990s (apart from during a few months during the 2008/2009 crisis), says Helen Thomas in The Wall Street Journal. All this could spell opportunity. We’ll be taking a closer look at the mining sector in next week’s issue of MoneyWeek.