Copper and oil are just the beginning – expect more money printing soon

The sliding prices of copper and oil are no surprise. And unless central banks provide more stimulus, the price of every other asset class will fall too. John Stepek explains why.


As China has stopped building, demand for copper has dried up

The copper price has tanked.

The oil price has tanked.

People are panicking about why this has happened.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

But there's no real mystery. This is what happens when you stop artificially stimulating an already over-priced sector.

And unless more stimulation arrives soon, they won't be the last assets to fall.

Here's why commodity prices soared in recent years

We wrote about this a great deal in the early-to-mid-2000s when everyone was marvelling at rising commodity prices and predicting that they couldn't last. So I'll give you the executive summary.

Three main factors drove the commodity boom: rampant demand from China; years of under-investment (due to low prices rendering most projects unprofitable); andfloods of cheap credit, which amplified the whole thing.

Vast amounts of infrastructure building in China sent demand for raw materials soaring. The pre-2006 US property bubble driven by cheap money also helped.

At first, miners and oil drillers burned by years of bear market couldn't keep up. Then as always happens high prices bred a complacent sense that prices would never fall.

Investors, desperate as always to pile into anything that was going up, poured money into resources stocks. Investment banks never ones to look a gift horse in a mouth found wonderful new ways to legally bilk the naive by setting up complex financial structures that funnelled more money directly into commodities markets and lots of lovely fees their way.

Then the 2008 sub-prime crisis hit. Global demand literally dried up overnight as the financial system seized up. The prices of everything (except bonds) fell. That's the last time we saw a commodity crash of this magnitude.

But prices rebounded. This time it was down to more cheap money and more demand from China. But this was very much a case of artificial demand. In the developed world, we had quantitative easing coming out of every pore.

Meanwhile, China needing to prop up economic growth as demand for its manufactured goods plunged launched a massive stimulus programme, funding the construction of more roads and railways stretching between cities where no one lived or worked.

If you want to get all Austrian about it and, as you might have noticed, I usually do then we've seen a good five years or so of rampant capital misallocation, driven by governments desperate to keep various shows on the road.

The pre-2008 commodities boom had its roots in a true' story. We had under-invested in resources for a long time. So when China's economy started to boom, there wasn't enough stuff' to go around.

But nothing goes on forever. And I'd argue that the sharp recovery in commodity prices from 2009 onwards was basically an echo bubble, driven by stimulus and force of habit.

The reasons behind the commodity price crash are straightforward

You can point to over-supply US shale oil is definitely a big factor for the oil price, for example. The picture is different for every commodity. Some even argue that copper over-supply isn't significant enough to justify the recent plunge. But the point is, there's enough.

But that's been the case for a while. So what else has changed?

We all fret about demand. But the most obvious factor here is that China has decided to become a consumer-focused economy. It isn't building as much, so it just doesn't need as much stuff. That's not necessarily grim news for the global economy. It just means they've got more than enough roads for now.

Should we demand they dig more pointless holes and throw up more uninhabitable concrete so that we can all pay more for our natural resources and maintain some sort of illusion that the global economy is roaring along?

There's one other obvious factor. Money printing.

The Federal Reserve has ended quantitative easing. People are now wondering about interest rate rises. The US dollar has shot up. And by an incredible coincidence, the commodity complex pretty much entirely priced in US dollars has plunged at roughly the same time.

Expect more money printing any day now

So the reasons are pretty obvious. What's less obvious is the outcome.

All else being equal, I think it's fair to say that lower prices for raw materials are a good thing. It means everything costs less. Some economies and sectors will hurt, but others will gain.

However, if this crash is at least partly triggered by the end of QE, then you have to wonder what it says about every other asset class. Have stocks been helped by QE? Yes. Have bonds? Yes. Has property? Yes. In fact, is there an asset class out there that hasn't really been buoyed by cheap money? Not really.

So unless someone else pulls the trigger fast, chances are that other asset classes will start to follow the commodities sector.

And that's why I reckon that Mario Draghi is going to surprise everyone next Thursday when the European Central Bank makes its big announcement on quantitative easing.

I'll have more on that in a Money Morning next week. But this is already shaping up to be one of the biggest financial stories of the year. (We'll have plenty about it in MoneyWeek too if you're not already a subscriber, take advantage of our eightfree issues offer today I've heard murmurings that we'll be going back to the usual four very shortly, so sign up now).

John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.