If you believe in the theory that commodity price demand points to economic growth and a healthy economy then the last two years have served to blow a rather large hole in that theory.
In fact looking at commodity prices over the last two to three years, while equity markets have gone higher, commodity prices have done the exact opposite.
It’s therefore not that surprising that there is so little underlying price inflation in the world when we’ve seen widespread declines in commodity prices across the board, as well as a sharp decline in oil prices, in the last six months.
Having said that given the sharp rises seen since 2009 in commodity prices, these falls are more than welcome at a time when we haven’t seen much in the way of wage growth, so in essence what we’ve seen in the last few months is simply a reversal of the income squeeze seen since 2009.
This is by no means a bad thing and is likely to act as a fiscal stimulus all by itself, in terms of lower input prices for companies and lower shop prices for consumers.
While it’s not such good news for the basic resource sector it will likely make the sector much leaner in terms of cutting its costs, and for when prices start to tick upwards again, which in the short term doesn’t seem that likely at the moment.
The poor performance of commodity prices also helps explain the poor performance of the basic resource sector over the past 12 months and the fact that the FTSE
100 and the Australia ASX have underperformed a lot of their global peers in terms of stock market performance this year, due to the heavy weighting of both indices to the commodity sector.
The Reuters CRB benchmark index of commodity prices is trading below five year lows, down 15% on the year, and nearly 35% down from its 2011 all-time highs. Anyone looking for evidence of a turnaround in the low inflation story of the last 18 months should keep an eye on this index for signs of a turnaround in prices. At the moment that looks unlikely with potential for prices to drop further towards the 2009 lows at $200.
This would appear to be great news for GDP growth for oil consuming countries, not so much for oil producing countries, as well as the European Central Bank where officials hoping for a pick-up in inflation could well be waiting a very long time.
Commodity price performance 2013
When we analysed commodity price performance just over a year ago in 2013, the best performing asset had been Brent Crude, which finished the year virtually unchanged, a little surprising given the geopolitical concerns surrounding this particular benchmark.
These concerns did initially carry over into 2014 with the multiple crises in Ukraine, Syria and Iraq helping underpin prices, but even then the absence of a significant push higher, given all these concerns, was starting to beg the question as to whether a sell off was only a matter of time.
While stock market performance this year has been choppy at best with US markets once again leading gains to new record highs, European markets have struggled to keep up, with only the German DAX making new records, but even here these gains proved somewhat short-lived.
2014 has been pretty much a case of more of the same in the commodity space only this time it’s been oil prices that have plunged off the cliff hitting their lowest levels since 2009, and down nearly 50% from their summer highs.
Commodity price performance 2014.
This oil price decline can partially be explained by concerns about a drop off in demand in emerging markets, as well as a slowdown in China as the economy there struggles against a backdrop of a slowing property sector and weaker export markets.
This weakness in the global economy has also translated into the rest of the industrial sector as copper, platinum and silver prices have also remained weak, also on the back of slower than expected global growth.
Not surprisingly the weakness in commodity prices has seen the mining sector and the oil and gas sector take the largest hit and explains why of all the major benchmarks the FTSE100 has underperformed its global peers, and once again frustrated those forecasters who predicted we would surpass 7,000 this year.
It’s been quite hard to find a silver lining in the commodity space in 2014, with oilfield services providers being hit the hardest, with Tullow Oil down over 50% and Petrofac down over 40%.
Even amongst the blue chips of BG Group and BP the rise has been one of the rollercoaster variety, with BG down over 30% and BP down over 10%.
Royal Dutch Shell has been a beacon of stability for its shareholders virtually unchanged from where it finished at the end of last year, testament to the reorganisation program currently being undertaken by its new CEO Ben Van Beurden.
Assuming that we are near a base in oil prices then there could be an argument for suggesting that some of the declines seen this year in the oil and gas sector might be overdone, particularly amongst some of the biggest losers. It would still take a brave man to try and catch this particular falling knife though, given how sanguine Saudi Arabia appears to be about recent drops in the oil price, which would seem to suggest we could see further losses towards the lows seen a few years ago near $40 a barrel..
This continued disconnect between cyclical growth stocks and the wider market is one of the reasons why predicting the direction of market movements has been so difficult over the last few years, and could well remain so as we head into 2015.
For the first two years after 2009 copper and global equity markets moved in lock step with each other, before the correlation broke down at the beginning of 2011, and while the S&P500 and DAX have made new record highs, the key question for next year will be whether they can continue to do so against a backdrop of a stronger US dollar, a tightening Federal Reserve and a European Central Bank that is likely to be hamstrung in further attempts to boost economic growth in the euro area next year.
With global growth forecasts continuing to remain on the low side the prospect of a pickup in demand for commodities probably remains less tilted to the downside than it did a year ago. This is because given the declines we’ve already seen in the past two years, these lower commodity prices could well provide a fiscal boost for economies all by themselves.
Even so that doesn’t mean that we will necessarily see a strong rebound either as margins in the sector could well continue to remain under pressure as revenue expectations get revised lower, and GDP growth remains subdued.
With the Reuters CRB index now below its 2010 lows, the next key level comes in at the 2009 low, near $200 that we saw just prior to the start of the Feds massive stimulus program in March of the same year. This would seem to suggest that while we could well see further declines in the short term that we might be approaching a key support area for wider commodity prices.
Much will depend on the struggle between OPEC producers and non-OPEC producers for market share in an environment which is markedly different from twelve months ago, as the US shale revolution blunts OPEC’s ability to set prices to suit its own price agenda.
This isn’t likely to change in the near term either, given the fact that Chinese demand is likely to remain weaker in 2015, while the economic recovery in Europe is also likely to remain fragmented given the political pot holes facing investors in 2015.
Notwithstanding the debate amongst ECB policymakers about how they can embark on a full scale bond buying program, and the jury remains out on that particular bit of wishful thinking on the part of investors. We also still haven’t seen the full effects of Russian sanctions bite properly yet, while elections in Greece, Portugal, Spain could have the potential to spook investors given the rise in support of anti EU parties in all of these countries.
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