There’s gobs of money chasing assets these days but there’s no “bubble” in commodities, which are tanking.
It’s not just gold, which gets a lot of headlines; nearly all major global industrial commodities are back to 2009 levels — including coal, gas, oil, iron ore and copper. Agricultural commodities such as wheat, coffee and sugar have also fallen on hard times. The dollar’s rally has certainly been a factor in the price action, with the greenback advancing versus other major currencies amid speculation the Fed will start raising rates sometime this year.
The other big story is China, which reported better-than-expected second-quarter growth of 7% last week, a development that notably didn’t change the downward trend for commodity prices. As the following charts demonstrate, China’s imports of oil, iron ore, steel and aluminum all fell sharply at the start of 2015, prompting Morgan Stanley to cut its 2015 outlook for most base metals back in March.
China’s import demand was “noticeably weak in the first quarter,” The World Bank says in its April Commodities Outlook report. Initially, the weakness was widely attributed to the Lunar New Year holiday falling into February this year “but the typical post-holiday rebound did not
appear to materialize in March.”
[As an aside, China’s falling demand for commodities is “not a necessary consequence of a transition to consumer-led growth,” according to Louise Keely, president of The Demand
Institute, a think tank jointly owned by The Conference Board and Nielsen. “In any structural change the relative demand for different production inputs will change but that does not necessarily lead to a fall in the absolute demand.”]
China’s exports of refined oil and metals have also fallen substantially, with the three month moving average at negative 2% versus a year ago, compared to a range of up 20% to 30% in the 2010-2013 time frame, according to Ashraf Laidi, CEO of Intermarket Strategy, a London-based analytical firm.
Partially as a result of China’s falling demand, “weakness [in commodity prices] is expected to continue for the rest of the year before recovering moderately in 2016,” according to The World Bank, which also cited “abundant supplies” of many key commodities, most notably oil — and that’s before any sanctions against Iranian crude are lifted. (This week, Morgan Stanley analysts warned that oil’s slump could be “far worse than in 1986.“)
Weakness in commodity prices has taken a toll on mining, exploration and related stocks, which is to be expected. A number of companies have specifically cited China’s slowdown as the main culprit for missing results in the second quarter, including United Technologies (UTX), IBM (IBM) and Caterpillar (CAT). Even Apple (AAPL), which said China accounted for 60% of its revenue growth for the June quarter, warned of potential “speed bumps” ahead in the world’s most populous nation.
Still, with major averages recently at all-time high levels, the Street has taken a generally sanguine view of the carnage in commodities and China. CNBC.com put out a piece entitled ‘Why the commodities crush is very good for stocks’ and Bloomberg’s Joe Weisenthal Tweeted a chart heralding the outperformance of stocks versus commodities as “another reminder that human ingenuity is better than rocks.”
But what are the implications for the global economy?
When it cut its 2015 global growth forecast earlier this month, the IMF cited lower commodity prices as a threat to emerging market and “low-income developing economies” but didn’t extrapolate the weakness in commodities as a signal of problems in the G7. “In advanced economies, accommodative monetary policy should continue to support economic activity and lift inflation back to target,” the IMF declared.
Fed Chair Janet Yellen struck an optimistic tone during her Congressional testimony last week, during which she cited the overall benefit of falling energy prices. “Consumer spending has picked up… many households have both the wherewithal and the confidence to purchase big-ticket items,” she said. “Prospects are favorable for further improvement in the U.S. labor market and the economy more broadly.”
Indeed, as the chart below from Evercore ISI shows, recessions tend to follow spikes in commodity prices, not declines.
“Absolutely not,” is how Carol Pepper, CEO of Pepper International, answers a question about whether falling commodity prices are a harbinger of weak global growth. That said, she is recommending her high net worth clients avoid commodity-related stocks for the foreseeable future, believing there are better opportunities in other sectors.
Still, the bears believe slumping commodity prices signal trouble ahead.
“The whole global economy is at extremely dangerous point,” says Chris Nelder, an independent energy analyst and author, who notes that falling energy prices, particularly, should be prompting analyst to project higher growth rates, “not just in the U.S., but elsewhere.” Instead, the IMF, the World Bank and most big commercial banks have been cutting growth estimates — and not just for China.
Last week I wrote about how the U.S. consumer is poised for liftoff, and most economists believe the U.S. will continue to outperform other developed economies. But the strong dollar has negative implications for U.S. growth too, according to the New York Fed, and it’s asking too much for American consumers to be an engine of growth for the world economy — it didn’t work out so well the last time.
- Morgan Stanley
- The World Bank