The commodities bear market looks entrenched. Strong supply-side responses, or successful economic stimulus by the European Central Bank, would be required to reverse price falls. Neither looks terribly likely.
There is no dearth of reasons to explain a 12 percent decline in the Thomson Reuters-Jefferies CRB index of commodity prices in the past three months. First, there is the ascendancy of the dollar, whose index has hit four-year highs and looks likely to climb a lot further. Commodities are priced in the U.S. currency. So, as the greenback gains in value, fewer dollars should be required to buy them. While this relationship doesn’t always hold, correlations show the linkage is near-perfect at the moment.
Then there is the prospect of tighter U.S. monetary policy. Investors are clamouring for assets which generate income. Higher U.S. interest rates, and an accompanying rise in U.S. bond yields, will make it even less attractive to hold commodities, which offer no income at all and are of little use as a store of value in a low-inflation world.
Next, there is moderating Chinese economic activity. Commodities used by industry, iron ore in particular, are bearing the brunt of this slowdown even if one or two have managed to escape the downdraft for idiosyncratic reasons – such as Indonesia’s ban on unprocessed nickel ore.
So, what might rescue commodity prices? A show of discipline by suppliers would help. Such unity is possible from the oil producers, who could agree to reduce supply when they meet later this year. It is harder to see it coming from the big miners. Rio Tinto and BHP Billiton have, for example, chosen to ramp up iron ore output despite concerns of an oversupply.
A pick-up in economic activity and inflation in the euro zone would also support commodity prices. While the European Central Bank is pumping more and more money into the financial system to lift inflation, it has so far had limited success. Falling commodity prices will only exacerbate its “lowflation” headache.
It would be naive to think that markets never confound apparent certainties. But the evidence suggests investors should dig in for further commodities weakness.