Carnage in commodities

Well, there goes the commodities supercycle of the early 21st century. The Bloomberg Commodity index, which tracks the prices of 22 raw materials, has hit its lowest level since the late 1990s. Down around two-thirds from its 2008 peak, and by a quarter this year, it is heading for the worst of five straight years of declines. All but one of the 22 commodities have fallen in 2015; the outlier has been cotton, up 4%. The worst performance has been natural gas, down 50%.

Healthy supplies, lower demand, and a strong dollar, which weighs on raw materials because they are priced in dollars, have been the main problems. The prospect of higher US interest rates can also hamper commodities – they have no yield and thus look less appealing than other assets.

Is this the bottom?

The mood is now so bad that some hope we could have hit the nadir. The American futures regulator has stopped publishing data on commodity index investments, apparently because barely anyone is interested any more. Meanwhile, reckons Gadfly on Bloomberg.com, the range and savagery of this month’s dividend and investment budget cuts in the mining sector “feels like industry executives who are either at, or close to, capitulation”.

Oil has grabbed the headlines again this week, with Brent futures slipping to an 11-year low of around $35 a barrel. Yet “it’s not exactly looking as if there is light at the end of the tunnel”, as Saxo Bank’s Ole Hansen puts it. The glut just keeps getting bigger, with Iranian and Libyan oil now looking set to return to market and oil cartel Opec pumping at full throttle to drown the American shale industry.

But shale “continues to confound its doubters”, says Kevin Baxter of The Wall Street Journal. The number of rigs rose by 17 last week, so the “predicted free fall in production” in early 2016 is unlikely to occur. Few now expect the market to come back into balance before 2017, and Goldman Sachs thinks oil could fall to $20 a barrel next year.

Glimmers of hope for metals?

When it comes to the base metals, investors shouldn’t get too excited either. Production cuts will take time to come through, and the magnitude of the cuts we have seen so far “is not sufficient to support prices”, except potentially in the nickel market, according to Deutsche Bank. “We only expect a price stabilisation in 2017, when the markets start to look more balanced.”

But could this be too gloomy? The gloom on China, the key driver of metals demand, may be overdone. Longer-term, its demand growth is dwindling as the economy shifts away from capital investment. But for now, the outlook is improving. In volume terms, commodity imports rose by 17% year-on-year last month, the biggest jump in two years, says Capital Economics. Recent monetary stimulus and infrastructure spending is “feeding through into domestic demand”.

All this suggests that there could be scope for a rally in metals prices in 2016. But given the supply picture, the high dollar and relatively subdued demand growth outside the Middle Kingdom, any rally seems unlikely to mark the start of the next long-term up-cycle.