With oil well below $100 a barrel and predictions of further falls in both oil and other key commodities, it’s another theme of the moment, as US financial chaos is only likely to increase pressure on commodities markets, says Stephen Wyatt, a savvy, China-based commodities commentator for the Australian Financial Review.
In a Monday column, Wyatt says commodities are still searching for fresh and lower equilibrium price levels in the face of a potential financial meltdown in the US and a collapse in the demand side of the commodity price equation.
The downward momentum of commodity markets will be halted at times, as they were late last week, by bouts of US dollar weakness or supply disruptions, he predicts. But the extreme uncertainties created by US financial turmoil is “severely damaging confidence in commodity markets” – even more so as it becomes clearer that US government efforts to restore confidence in the financial system “are not working”.
Commodities markets are driven mainly by industrial production growth around the world and by soaring Chinese demand for raw materials.
US and European growth is slowing, retail sales are weakening, and industrial production growth in developed economies is falling.
Hedge funds are running for cover as redemptions from investors accelerate. A number have already gone under with the closure of the Ospraie Fund raising expectations that many more would follow.
But there’s still about $200bn sitting in commodity focused hedge funds, says Wyatt, and “China remains a bastion – the last bastion, of support for commodities”.
Strong Chinese buying of copper late last week was one factor behind the recovery in base metal prices, athough the sharp decline in the US dollar was the major driver of a general rise in commodity prices.
Gold rose $25 an ounce Friday and over the weekend to trade at $764 and the oil market managed to stabilise, albeit after breaking down through $100 a barrel for the first time since in almost 5 months.
But these markets remain 20-50 per cent below their all time highs, and the resources boom under way since 2001 has hit its cycle highs, notes Wyatt.
And while China from a macro-perspective looks strong, he says, from a bottom-up perspective the economy looks like it is in trouble. Commodities markets are now trying to reconcile this contradiction:
China’s property, construction and export sectors, particularly exports of textiles, shoes, toys and electronics, are in contraction.
Exporters in Guangdong are rapidly closing. The factory of the world is shrinking. China’s planning body, the National Development and Reform Commission reported that 67,000 factories were closed in the first half of this year. And closures are expected to rise in the second half.
Property sales in major Chinese cities have fallen by more than 40 per cent over the past 2 months and prices are down by 20-30 per cent.
The slump in the Chinese property and construction sectors will crimp demand for steel, stainless steel, nickel, iron ore, copper and aluminium. China’s construction sector accounts for 56 per cent of China’s total steel consumption.
Growth is expected to decline next year to around 8 per cent and that rate of commodity intensive growth would still provide support for resource markets.
Ultimately, no-one knows what toll that slowing Chinese exports and slowing construction will take on the Chinese economy. But, concludes Wyatt, “certainly a large fiscal stimulus package is seen as needed and this is what economists expect will keep growth around 8 per cent rather than 5-6 per cent”.
Either way, a concerted slide in commodities prices will have big implications for headline inflation globally, the FT notes in an editorial comment on Monday:
Divergences between headline and “core” inflation (from which energy and food, in particular, have been stripped out) have become remarkably large in the past year, particularly in the US, and the painful dilemma for policymakers has been whether to focus on the financial crisis or on rising headline inflation.
Behind these huge divergences were extraordinary surges in commodity prices, particularly of energy and food, in recent years.
Now, says the FT, “for good or, more probably, ill, the dilemma is on its way to resolution. Contractionary forces are winning. If so, this does at last clarify priorities”.
These huge jumps in commodities prices are now reversing, partly because of the global economic slowdown and partly because of adjustments to the high prices themselves The price of oil, in particular, has fallen from a peak of $147 a barrel to close to $100. Between June and August alone, the Goldman Sachs composite commodity price index fell 18 per cent. Even non-energy prices fell 11 per cent over this short period.
Unless these falls in commodity prices reverse swiftly, which seems unlikely in today’s somewhat grim economic circumstances, we can expect a period in which headline inflation starts to converge on – and, quite possibly, falls below – measures of core inflation. This may take a little while, but the great likelihood is that the inflation picture will look substantially less dire by the end of this year, with further improvements likely in 2009.
What that means, is that unless core inflation rates start to jump or the falls in commodity prices reverse, central bankers will be able to shift attention from inflation. If they recognise the strength of the contractionary forces now at work – as they should – the next moves in interest rates will surely be down; and concludes the FT, “they should come quite soon”.