One of the largest U.S. banks says the commodities super cycle is dead.
The soaring growth of China and other developing countries in the last 10 years led to fast growing demand for all the raw materials needed for expanding construction, manufacturing, transportation and for increasingly prosperous people, including metal, minerals, energy and agricultural goods.
That drove the price of commodities higher as demand exceeded supply. The high prices rationed demand and encouraged producers to invest to increase output.
Strong commodity prices also affected exchange rates, with the currencies of countries that produce a lot of commodities, like Canada’s loonie, rising against other currencies.
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But now many analysts say slowing growth in China, anemic European and American economies and increased output of commodities have put supply and demand back in rough balance.
Citigroup Global Markets Inc. issued a report last week that said “the death bells ring for the commodity super cycle after its duly noted sunset.”
The coming decade will present opportunities “based on how individual commodities will perform against one another and against broader market indicators such as equities or currencies,” the Citi researchers said.
I’m no economist so I can’t say if Citi is right, but it is clear that for investors, commodities are not the money makers they were a few years ago.
For this year, the place to be has been the U.S. stock markets where indexes have climbed 15 percent or more and the Dow and Standard and Poor’s 500 are at record highs.
We have seen a lot of fund money exit commodity investments and move into the stock market.
This does not necessarily mean that commodities will become a money loser and as Citi noted, commodities vary in their nature and in their performance relative to each other.
The annual production cycle on a farm is a lot different than a mining company’s decision to spend billions of dollars and five years developing a new mine. The farmer has more ability to quickly make minor adjustment to production than the miner, but is far more dependent on the weather.
The implication for farmers and the prices they receive for their crops and livestock during a dying commodities super cycle is perhaps subtle.
A commodities boom attracts investment money and speculators. That money does not necessarily alter price trends created by supply and demand fundamentals, but when it rushes in to a rally or decline, it can make swings more volatile, with the highs higher and lows lower.
The future of commodities is also affected by the central bank stimulus policies of several major economies, including the United States and Japan.
With interest rates already at historic lows, central banks are using other tools to increase the money supply with a desire to increase bank lending and consumer and corporate spending.
That is supposed to kick start weak economies and reduce high unemployment rates.
The U.S. Federal Reserve, known as the Fed, has had three rounds of stimulus since 2008, with the tongue twister name quantitative easing.
The latest, called QE3, essentially prints money, pumping $85 billion a month of new greenbacks into the U.S economy.
It is a blunt instrument with all sorts of influences. When you increase the supply of something, its price is supposed to fall, so the value of the U.S. buck should fall, lowering the price of commodities priced in the currency. But the buck is hanging in pretty strong.
It is also supposed to spark a modest rate of inflation to encourage spending now because the price will be higher in the future. But U.S. inflation is running about half the Fed’s target of two percent,
Some analysts say QE3 is helping to fuel the U.S. stock market rally and some say it is helping to lower the unemployment rate, although job growth is fragile with good numbers one month followed by disappointments the next.
The Federal Reserve has stated it intends to keep running QE3 until the U.S. unemployment rate falls to 6.5 percent. It now stands at 7.5 percent.
But Fed officials are split on how effective the policy is and how long to continue it.
Last week, three Fed officials said QE3 should end as early as this summer. That sparked a rally in the U.S. dollar and weighed on the futures price of several commodities.
If QE3 actually ends earlier than expected, it could be an additional negative factor for commodity values.
These broader factors certainly won’t have the kind of effect on grain prices as, say, three weeks of hot dry weather in the Midwest in July, but they do affect the market environment.
To use a real estate analogy, it is easier for the price of your house to rise when you live in the hot new neighbourhood with trendy coffee houses opening than when they discover it sits atop an old burial ground and spooky apparitions are sighted at midnight.
