Reunited by bubbly
The often close correlation between equity and commodity prices has faded. World equities are up 15 percent since August while commodities have barely moved. Is this a paradigm shift? Probably not, though shale gas is rattling energy markets. Equities may simply have run too fast on the back of quantitative easing while commodity investors have hesitated over global growth worries.
As long as QE keeps fuelling global liquidity, investors in both asset classes can remain relatively sanguine. The big new factor is Japan’s entry into the money-printing race. For risk assets such as equities and commodities, the QE competition between the United States and Japan is a boon. The U.S. Federal Reserve is printing $85 billion in new money per month. According to Masaaki Shirakawa, the governor of the Bank of Japan, the BOJ’s “unlimited easing” will consist of around 50 trillion yen ($550 billion) in funds in 2013 and a still-higher 13 trillion yen ($143 billion) per month from January 2014.
Commodities may be lagging in part thanks to the dollar. In previous “risk on” episodes the greenback tended to weaken, pushing up commodities, which are mostly priced in dollars. But in 2012 the dollar appreciated slightly, and Japan’s fresh monetary stimulus is directly targeted at weakening the yen. The dollar has softened against the euro, but the currency has been stable since September against the trade-weighted basket of international currencies.
Aside from the influence of the dollar, commodity investors may be fretting about fundamentals in a way that equity investors are not. Global growth was lacklustre in 2012, creating fear of weak physical demand for commodities. In addition, there has been one definite supply-side shift: cheap U.S. shale gas, which may be unsettling oil and other energy prices. Equity prices, however, may be less influenced by growth figures than valuations. With yields on safe-haven bonds at record lows, valuations look attractive. The MSCI world equity index trades on a forward multiple of 13, compared to a 20-year average of 16.
The worst economic fears, meanwhile, have not materialised. Chinese growth and commodity demand haven’t collapsed: iron ore imports, for instance, rose 8.4 percent in 2012. And with the euro zone crisis in abeyance, the prospects for global growth in 2013 are improving.
The correlation between equities and commodities may therefore tighten again, especially if share prices pull back a tad. But both asset classes remain attractive – while the QE tide continues to flow.