In the last few weeks a slow slide in commodity
prices – metals in particular – has turned into a full-scale
nosedive.
All through 2011 copper had remained essentially between
US$4 and $4.50 a pound, but on September 11 it dropped below that range and
didn’t really stop falling until October 4, when it bottomed at $3.05.
Aluminum gained ground in the first half of the year to reach $1.24 per lb.
in April, but after losing 10% in the last 30 days it is back below that, at
$0.96. The spot price of nickel lost 19% in the last month; zinc prices fell
17%. Precious metals were not spared either: The price of silver shed a
whopping 33% in 30 days, while gold is currently down 15% compared to its
price on September 6.
Grouping the commodities together really shows how
rough the last few months have been. The Standard & Poor’s GSCI
– an index of raw materials that tracks 24 commodity prices – is
down 24% since April, when it hit a 32-month high. On October 4 it touched
572.92, its lowest level since November 26, 2010. Falling metal prices were
the main culprit: Silver closed at its lowest price since February, and
copper saw its cheapest settlement in 14 months.
The slide in commodity prices ends a period of
discord between a global economic story of frailty and impending doom and
commodity prices that were holding their ground at or near record highs. The
disparity stemmed in large part from opposite outlooks for the world’s developed and emerging economies –
Europe and the US are struggling to maintain any kind of economic momentum
but emerging economies have continued to grow, led by China. Investment
actions (encouraged by the printed money stemming from QE2) then heightened
that difference, as investors turned to commodity prices to profit from
emerging-market growth.
The investments that fed the disparity came from a
very broad base. It used to be that investing in commodities was only for
institutional players and real market participants, but over the last decade
a slew of retail investors have jumped on board the “good-times
commodities train.” Since the start of the current commodities supercycle in the early 2000s, investing in raw materials
shifted from a risky, hard-to-access game to a commonplace portion of most
portfolios.
Before, most ordinary investors were only exposed to
commodities by owning shares in oil or mining companies. Now, a broad range
of commodity-based exchange-traded funds (ETFs) spanning agriculture, energy,
and metals have given investors access to direct exposure to raw-material
price swings… and the sector has provided such consistent rewards that
many financial advisors and pension managers now believe that all ordinary
investors should have some slice of their long-term money parked in
commodities. The assets of ETFs and similar investment products that hold
baskets of commodity futures have increased sixfold
since 2007, reaching a value of $37 billion this summer.
In recent months, however, the tide has turned in a
major way. Investors and advisors are beating a hasty retreat from all risky
holdings, and for many that includes commodities. Current global economic
uncertainty is pushing investors toward very low-risk options, starting with
US bonds and ending with dividend-paying utilities. Commodities, which were
previously better-insulated from retail investor panics, are feeling the
pain.
Of course, retail investors abandoning ship only
account for a small part of the pressure on commodity prices. Commodity
prices are complex beasts, with annual variations relating to contract talks,
stocking seasons, de-stocking seasons, currency ratios, and speculative
action.
Take copper as an example. China accounts for
something like 40% of global copper demand, and its unceasing demand growth
helped copper prices rebound quickly after the 2008 recession. Whether this
demand growth will continue is a topic of much debate.
The bears point to tightening monetary conditions
and a global slowdown to argue that China’s economy will grow just 5%
this year – a sluggish rate, compared to its double-digit expansions
over most years in the last decade. They also point to reports of very large
speculative stockpiles in China, accumulated in part as a way to skirt bank
lending restrictions imposed by the Chinese government. The copper bulls, on
the other hand, argue that demand is holding up well. Volumes at most
companies are still up year on year; even in Europe, Germany is still showing
reasonable growth; and in the United States the copper rod market is expected
to register 3% growth – that would be down from 6% last year, but it’s still growth. As for China, the bulls expect 8%
economic growth and say it is merely a matter of time before the Chinese
return to the market and restock heavily. Minmetals
stoked that fire somewhat last week with its C$1.3-billion bid for Anvil
Mining (T.AVM), a copper company.
In addition to all of those factors and arguments,
the scrap market plays a role. The “urban mine” of recycled
metals accounts for roughly one-third of global supply, but as prices fall
scrap flows slow down significantly. That tightens the market even if demand
also weakens. Many scrap dealers are holding on to their copper until prices
recover; they did the same in 2008-‘09, helping to push prices up.
So commodity prices are complicated and difficult to
forecast at the best of times, which is not exactly how we would describe
things at present. Yes, that’s our lead-in to saying that predicting
where prices are going from here is a challenge, to say the least.
Again, let’s use copper as an example. Copper
price forecasts now range from below US$6,000 per tonne
(from the head of the copper department at Minmetals)
all the way through to $10,075 (from Barclays Capital). Goldman Sachs, Credit
Suisse, and Standard Bank are closely aligned in their outlooks, all
expecting copper to sit just under $9,000 per tonne
through 2012.
Certainly, the fundamentals of the copper market remain
very tight. Based on current demand predictions, the International Copper
Study Group expects to see a deficit of 250,000 tonnes
in the global refined copper market in 2012, before moving closer to balance
in 2013. To put 250,000 tonnes into context, global
demand for refined copper products in 2010 averaged 19.4 million tonnes. And it is important to remember that current and
forecast copper prices all sit comfortably above the break-even point for
producers. The marginal cost to produce a tonne of copper
averages between $4,000-US$5,000, creating a solid floor
for spot prices.
But as one Credit Agricole
analyst pointed out, “the fundamentals just won’t matter in a
financial panic.” We’ve already seen some of that irrational
movement: Copper’s lowest point this week, of $6,635 per tonne, represented a 33% decrease over just two months.
The metal boasted a spot price just below $10,000 at the start of August.
Really, commodity prices from here will depend on
whether Greece defaults in an orderly, supported manner or goes down in an
uncontrolled inferno, torching Europe’s books for years. Both are still
options. A planned default has its downsides – as German Chancellor
Angela Merkel puts it, “If we tell a country ‘We cancel half of
your debt,’ that’s a great deal. Then the next guy will
immediately show up and say he wants the same.” Nevertheless, the only
way Greece can survive its suffocating debt levels is through some kind of
default, and if the European Union can come up with a default management plan,
then the other countries of the Union could be protected from the worst of
the fallout.
An unplanned,
“oh-my-God-how-did-this-happen?!” style Greek default, on the
other hand, could decimate numerous European banks and in doing so create
exactly the same maelstrom that gave birth to the 2008 recession in America.
Despite some bearish indicators and a lot of nervous
investors, a recession is not necessarily in our future. Goldman Sachs, the permabull of commodity price forecasters, remained
committed to its prediction that commodities will continue to outperform.
While reducing its oil and copper forecasts for 2012, the bank reiterated an
“overweight” recommendation on commodities over the next 12
months, explaining that the turmoil in Europe will take away “some of
the upside” to commodity prices, but will not reverse prospects.
“With recent GDP revisions by our economists
falling hardest on Europe but with emerging market growth expectations still
relatively solid, we continue to believe that demand growth in 2012 will be
sufficient to tighten major commodity markets,” lead analyst Jeffrey
Currie wrote. The group sees potential for commodity prices to climb as much
as 20% over the next year. Goldman did reduce its forecasts for oil and gas:
The bank now expects Brent crude to average US$120 per barrel over 2012, down
from an earlier prediction of $130, and expects copper to trade near $9,500
per ton, down from $11,000.
Barclays Capital added its voice to the chorus that
is trying to remind frantic investors that a recession is not guaranteed,
agreeing with Goldman that emerging markets could still save the world from a
significant recession while also limiting further commodity price slides.
Many people are still hopeful that that chorus is
singing the truth: These days any and every sign that we can avoid a
recession sparks a bull market day. On October 5, the day after copper, oil,
and silver all hit multimonth lows, commodity
prices across the board gained ground after Federal Reserve Chairman Ben
Bernanke said the central bank would take further measures to prevent a
recession if necessary. Bernanke said the Fed could ease monetary conditions
further, following the launch of Operation Twist in September.
We think it is likely that the commodities which fell
in September and early October were following the example set by oil in early
August. Crude prices were too high, having failed to fall in response to
increased stability in Libya and weakening demand. So they corrected: Brent
crude fell about 8%, while WTI crude lost roughly 14% in late July and early
August. Since then crude prices have been fairly stable; they dropped
somewhat while other commodities were flailing in September, but not
dramatically.
So perhaps the metals realized they were overvalued,
like oil had been given the global economic climate, and corrected. If they
are following oil’s footsteps, things should remain relatively stable
from here. But, as mentioned, that would require an orderly Greek default.
And given that the Greek debt ”crisis” has now been going on for
two whole years and Europe’s leaders have continued to respond with
solutions that are too little, too late, a significantly proactive step such
as planning for Greece’s default may be too much to ask. And in the
case of a frantic and disorganized default, commodity prices could easily
drop farther.
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