24th July 2015
Commodities are heading into bear market territory, with prices slumping in virtually all sectors thanks to a combination of weaker demand and increased supply.
Gold got the headlines this week as it fell to a five-year low as it notched up ten-straight session losses, but nearly all major industrial commodities are back to their 2009 lows.
The Bloomberg Commodity Index, which tracks 22 raw materials, dropped 7.2 per cent in July, reaching a 13-year low on July 22nd.
Coffee, sugar and wheat have all dropped, while copper, iron ore and other precious metals have taken a beating. Oil has retraced to below $50, dropping 20 per cent in six weeks to officially enter a bear market.
Certainly the recent strengthening in the US dollar has had an impact. Bets the Federal Reserve will hike rates this year have supported demand for the greenback, forcing dollar-denominated commodities lower.
The dollar index hit a three-month high this week, after comments from Fed chair Janet Yellen the previous week. Gold is particularly susceptible to a rising dollar as it costs money to hold and yields nothing. Higher interest rates in the US make holding gold less attractive.
But gold is only a small part of the story and not that important in terms of the wider economy. The other factor in the commodity rout is China.
A turbulent stock market has rocked confidence in Asia’s largest economy, while long-standing fears about a slowdown in the country are weighing.
Falling factory output in China is a big concern. The Markit/Caixin survey of China manufacturing fell to 48.2, a 15-month-low, well short of expectations and raises further questions about the state of China’s economy.
Less industrial demand in China matters a lot. It is the world’s largest copper consumer, guzzling 40 per cent of global output. The country’s move from industrialisation, which powered the commodity super-cycle that began in the 2000s, to a broader consumer economy, is a key factor.
For oil, the combination of rising US production, OPEC output and Iran’s nuclear deal is creating a perfect storm for prices again, which have slumped to their weakest since hitting six-year lows March.
Furthermore, there has been no let up in recent days as crude oil inventories rose by 2.5 million barrels last week to 463.9 million, according to the US Energy Information Administration. Crude output did fall slightly but remains close to a 40-year high in spite of the number of drilling rigs in operation down 60 per cent from their November peak.
Iran’s nuclear agreement will ease sanctions, including restrictions on oil exports, creating further pressure.
World Bank forecasts
The World Bank estimates metals prices to average 16 per cent below 2014 levels this year, a significant downwards revision from the 12 per cent of April’s forecast.
“The largest decline is expected for iron ore (down 43 per cent) due to new low-cost mining capacity coming online this year and next (mainly in Australia),” it said in the latest Commodity Markets Outlook.
“Metals markets are adjusting by closures of high-cost operations and reduced investment. Markets will eventually tighten, in part due to large zinc mines closures, and as Indonesia’s ore export ban weighs on supplies, notably nickel.”
The World Bank also expects agriculture prices to average 11 per cent below 2014 levels this year, revised downward from nine per cent in April.
It expects energy prices to average 39 per cent below 2014 levels with oil leading the way down. “Downside risks to the forecast include higher-than-expected non-OPEC production (supported by falling production costs) and continuing gains in OPEC output,” the World Bank said.
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