11th August 2015
Rowan Dartington’s Guy Stephens takes a look at the decline of commodities worldwide and the reasons behind this current predicament…
Almost all commodity markets have had a very painful experience recently, but this is a trend that has been entrenched for some time now.
The aggregate Bloomberg Commodities Index is down over 60% from its 2008 peak, and the last twelve months have just hammered this home. There has been no place to hide – gold, energy, industrial metals, and even soft commodities have all been weak. The rout can be partly attributed to a number of factors, either tainting sentiment within the sector or fundamentally impacting supply or demand. One of those factors is almost certainly China; an economy which has been such a dominant driver of demand for industrial metals in particular.
The slowing of (and evolution of) the Chinese economy is one that will have heavily impacted demand for copper, aluminium, iron ore… to name a few. Chinese demand for energy is also about to stop growing if you believe a number of government officials who are questioning the health of their country’s environment, claiming it is an issue that is now extremely high on the agenda in what is the world’s second largest economy.
Fundamentally, supply has also increased in a number of industrial metals but, more prominently, in oil production as the US shale producers have seemingly transformed that market. History tells us that oil has not previously participated in prolonged periods of downturn in commodity markets, but this time around, oil has seen the sharpest and most undignified fall of all. The fall from grace has been well documented, Brent crude futures plummeting from the dizzy heights of $100+ last summer, to the $50 per barrel that we stand at today. The rise of sustainable and alternative energy as well as improved energy efficiency in developed economies should also not be forgotten and this all points toward lower prices.
Gold has experienced a far more drawn-out, prolonged suffering. The market nowadays seems confused over the rationale for holding gold. The precious metal has traditionally been held for inflation protection, amongst other things, and this reasoning has often been attributed to the ramp up towards the peak of the gold price in 2011. Quantitative Easing was in full flow around the globe, and theory suggested this should be inflation inducing. However, this has not been the case. Instead, the developed world is stuck in a deflationary period.
It’s harder to explain the drop in agricultural commodities. A growing global population suggests demand should not be an issue. Supply has not been dramatically impacted, to our knowledge, by a run of bumper harvests. There has also been little in the way of major technological advancement. It could be argued that cheaper oil, which lowers production costs, may be the only reasonable explanation.
Economic super-cycle theorists will point to decade-long periods throughout history that tell a similar story to our current predicament. During these cycles, the real prices of all commodities (excluding oil) moved together. The boom period of the 2000s was arguably the most pronounced of all of these. So, are we therefore only at the beginning of an equally pronounced downswing?
The end result on equity markets is some heavily sector-distorted markets. Energy and Basic Materials sectors are trading on cheap multiples, in stark contrast to the remainder of the market. The value opportunity here must be tempting, but given the uncertainty surrounding the outlook, exposure here should be carefully sought in high quality companies who can ride out the tough times.