Commodity slump is overdue correction
Commodity prices fell further today after the substantial losses they recorded yesterday. High commodity prices fuelled concern over inflation and the sustainability of the global economic recovery. At the same time, the slump hurts investors who saw in commodities the opportunity to profit in an environment characterised by the weak dollar and low developed-economy interest rates.
What next
Soaring commodity prices in the last decade have not been a blip -- emerging-market demand is likely to sustain their 'supercycle' for the foreseeable future. Yet in the short- and medium-term, volatility will continue to take place. Lower commodity prices will reduce inflationary pressures in the coming months, giving central banks breathing space before starting or continuing to tighten policy. This would be a boon for the global economy.
Subsidiary Impacts
- Global inflationary pressure will ease over the next few months.
- Lower commodity prices and the end of quantitative easing may reduce financial flows to emerging markets, weakening their currencies.
- The longer-term outlook for commodities remains positive, though even the 'supercycle' will eventually come to an end.
Analysis
Commodity prices today were under downward pressure again following sharp falls yesterday, when the Thomson Reuters/Jefferies CRB Index, which reflects the price of a broad range of commodities, dropped by 4.9%. Energy and raw material prices fell across the board. For example, Brent oil fell by 8.3%, to 111.58 dollars a barrel. The losses reflected investor concern over the pace of the global recovery. Investors reacted especially to suggestions by ECB President Jean-Claude Trichet that the euro-area monetary authority will not raise its benchmark interest rates this month and to worst-than-expected data for unemployment claims in the United States.
Growth concerns
More generally, investors fear that high commodity -- notably energy -- prices are undermining growth. While by the same token reductions in such prices could benefit growth, short-term data do suggest that the recovery has lost steam:
- The JPMorgan Global manufacturing Purchasing Manager Index (PMI) reached in April its lowest reading for five months, indicating slower expansion in industrial production.
- Services PMI have also fallen in major economies such as the United States and China.
Market moves
Strategies adopted by major market players recently also help explain the reduction in commodity prices. Liquidity in global markets has been abundant as a result of loose monetary policy in most developed economies, especially near-zero interest rates and the second round of quantitative easing (QE2) in the United States (see US/INTERNATIONAL: QE2's real danger is limited potency - November 10, 2010). That has not only fanned a drop in the dollar in recent months, but also provided large sums to be invested elsewhere, to the benefit of commodity prices. With the end of QE2 approaching in June and the ECB postponing its interest-rate increase, the dollar recovered yesterday against the euro:
- Investors may be preparing for an environment of tighter monetary policy -- even in the United States.
- While QE2 and low interest rates have undermined the dollar value, the euro faces sovereign debt crises in Europe.
Many investors hedged against the weak dollar by buying commodities, with a key role for silver. Yet silver prices have declined strongly in recent days, prompting many investors to try to limit their losses by selling other commodities.
Real economy
Some 'real-economy' data also point to a correction in commodity prices (see INTERNATIONAL: Commodities could face short-term fall - April 20, 2011). Tightness may be lower than widely believed in key markets. On May 4, the US Energy Information Administration reported that crude oil inventories (excluding the Strategic Petroleum Reserve) were at 366.5 million barrels at the end of last week, up from around 335 million at the beginning of the year. This represents a mismatch with petrol at 4 dollars a gallon in the United States, meaning a correction was likely.
Meanwhile, demand for metals is also likely to lose some steam with slower growth in industrial production, while global food prices could face less pressure than in 2010 as a result of better harvests.
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