Commodities drop looks secular, not cyclical

By A Gary Shilling / BLOOMBERG

Any way you measure it, the market for commodities is suffering. The Bloomberg Commodity Index of 22 key raw materials ranging from oil to copper to soybeans has dropped about 10% since reaching an almost three-year high in May.

I’ve identified seven forces that explain the weakness and why it will persist.

1. Slowing economic growth globally and a possible recession in the next year. Commodity producers seldom moderate supply to match weakness in demand, and commodity prices drop in recessionary climates.

Harbingers of a recession — universally falling stocks, tighter US Federal Reserve monetary policy, the soon-to invert yield curve, weakening housing activity as mortgage rates rise, unsustainable corporate profit growth and soaring consumer confidence along with lower savings rates.

Copper is an excellent gauge of worldwide economic activity since it’s used in almost all manufactured goods and has no price-constraining cartel on the supply side or legal restrictions on demand. Copper prices are down about 16% since June.

2. The strengthening dollar is increasing the local currency cost of commodity imports in developing and advanced economies. I forecast the greenback, the world’s primary reserve currency, will continue to appreciate.

Of my broad list of 45 commodities, 42 trade in US dollars. High costs cut commodity demand and prices.

3. Slowing growth in China is curbing commodity usage as GDP advances drop from double digits before 2007 to 5.8% in the third quarter. China’s planned shift from goods exports and infrastructure spending to domestic consumer spending is disruptive. Furthermore, 53% of GDP last year came from low commodity-intensive services, up from 34% in 1995.

China’s growth will slow further since its unemployed labour force is nearing exhaustion and because its emulation of Western technology, enhanced by stealing American technology or requiring tech transfers as the price of doing business in China, is over.

China, like South Korea before it, is entering the “middle-income trap”. Furthermore, China’s labour pool will shrink in future years as a result of her earlier one child-per-couple policy. The 15-to-64 age group is set to fall from one billion in 2015 to 717 million in 2060.

4. As economies grow, proportionally less is spent on commodity intensive goods and more on services. You can drive only car one at a time, but spend almost unlimited funds on travel, recreation, education and other services.

This is true for developed countries like the US where outlays on services climbed from 39% in 1947 to 69% in 2017. It’s also true for emerging markets like China, where the services component of GDP rose from 34% in 1995 to 52% in 2017.

5. The escalating trade wars disrupt economic growth and commodity demand as uncertain business people postpone capital outlays. Supply chains are also disrupted. Many American companies don’t export to China, but depend on intermediate goods from that country.

In US President Donald Trump’s initial US$50 billion (RM209 billion) round of tariffs, 53% were on intermediate imports from China and 50% of the impending US$200 billion second round.

6. Mounting inventories depress commodity prices. Producers can’t be sure initially whether weakening demand is momentary or serious and don’t want to disrupt production. So, inventories climb.

After Trump’s tariffs curtailed exports of soybeans, stockpiles soared. Lack of pipelines to move oil has created a US$6.75 per barrel discount for oil in Texas’ Permian Basin compared to West Texas Intermediate crude at US$52 per barrel and excess inventories.

7. The realisation that a peak in oil demand, not supply, is on the cards. This comes as rising supplies of natural gas and liquefied natural gas, as well as renewables replace oil.

Renewables such as hydro, wind and solar accounted for only 12.1% of electricity generation last year, but the International Energy Agency forecast them to account for 56% of new generating capacity through 2025.

Due to conservation including more efficient vehicles, energy conservation per dollar of economic activity since 2017 declined by 43% in Canada, 61% in the US, 48% in Japan and 70% in the UK.

Mushrooming electric vehicle sales will slash crude demand since transportation accounts for about half of oil use and autos are around half of that, or 25% of the total.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.