Commodities take a Tumble: A Crisis of Excess
Commodities have taken a miserable tumble as a combination of forces act in synchrony and weigh down on global prices. On the one hand you have an unresolved Greek debt crisis to which there seems no end. President Karolos Papoulias has only today announced that Greece will yet again return to elections. It gives rise to the very serious possibility that Greece will indeed exit from the Euro-zone, a scenario few would have envisaged no less than a month ago. Then you have Italy, which seems to be heading into a Spanish-like demise in the wake of Moodys’ recently announced credit downgrade of 26 Italian banks, and with Spain’s borrowing costs already taking a serious toll, there isn’t much hope for the euro. With very little to be optimistic about, it is hardly surprising that banks are looking to minimize risk.
Guy Wolf, strategist at commodities broker Marex Spectron, stated, “the worsening situation in Europe has caused banks to batten down the hatches”. But it isn’t only Europe that is of concern. There are arguably greater worries stemming from China and the United States. Barring a sudden uplift in economic data, you can feel quite certain about a new round of economic stimulus come June. US unemployment figures are scarcely repairing the large-scale job destruction witnessed in 2008. But up until recently consumption could always rely upon the Chinese growth machine. Now, even China has started to show signs of slowing down. The latest figures indicate that Chinese industrial output has withered to its slowest pace in three years. April saw its industrial output expand at only 9.3 percent, well off track of analysts’ forecasts of 12.2 percent growth. Chad Morganlander, a money manager at Stifel Nicolaus & Co., noted, “there’s a slowdown in China, so there’s been a glut of several essential raw materials…couple that with an increased amount of political uncertainty as well as economic uncertainty in Europe, and that leads speculators to de-risk their portfolios”.
Interestingly, the benchmark Reuters-Jefferies CRB index, an indicator of the strength of several core commodities, has been revised to its lowest level in over 19 months. Similarly, the Dow Jones-UBS Commodity Index has declined by 5 percent in 2012 and is down by nearly 25 percent over the past year. The readings have prompted a re-examination of the factors contributing to such widespread price declines. In commodities, it is perhaps telling that companies have been acting in assumption that China would always remain in fifth gear. In the run up to 2015, Liberum Capital estimates that miners will spend about $200 billion in expanding production. According to the US Department of Agriculture, inventories in the US will increase 44 percent from the year prior. The department also predicted that total global inventories would represent figures as much as 10 percent in excess of original expectations. The margins of difference suggest that output might have been too optimistic about consumption rates, especially in the world’s fastest growing economy. With the Chinese slowdown and a vast decline in prices, perhaps global commodity markets are now being driven by excess supply.
From oil to aluminum, output has increased enormously. But with China showing signs of lethargy, perhaps there is just too much. We rarely see this sort of a reaction in the commodity indexes. And it comes at a time of political and economic turmoil. A European recession, a faltering powerhouse, and a struggling US economy give little hope that the problem will be repaired by consumption and demand. With world stockpiles set to climb 10 percent in the season beginning on August 1st, perhaps the commodities reflect a crisis of excess.