What is the commodities market trying to tell us? After a steady and almost uninterrupted rise since the recovery from the credit crisis that began two years ago, many of the most-watched commodities have staged a dramatic reverse this month. But the less remarkable performance of more humdrum commodities is more worrying.
Let us start with the unavoidable spectacle of silver. This year has seen the inflation and subsequent burst of a classic speculative bubble. In less than five months, it has gained 63 per cent and then fallen 35 per cent once more. Need this resonate beyond the silver market? Not necessarily. Silver has always been treated as an unruly speculative byproduct of gold. With precious metals in demand as an inflation hedge, it is not surprising that silver became detached from its fundamentals. Since speculation about a programme of bond purchases by the US Federal Reserve started last September, silver’s price more than doubled relative to gold, to a 30-year high, and then snapped back. As silver is still, at the time of writing, up 15.5 per cent for the year, it makes sense to see this as a correction of a brief but silly speculative bubble, not anything more sinister.
Turning to gold, its advance is a natural outcrop of a belief in the twin phenomena of resurgent inflation in the west and a debased US dollar. People buy it as the ultimate “hard” currency, which will hold its value if the easy monetary policy of the Federal Reserve leads to runaway inflation in the US. On this basis, gold, which has declined a bit in the past few weeks, is saying that fear of inflation reached a peak at the beginning of this month. This makes sense because the economic data coming out of the US and western Europe continue to be weak, with little or no sign of the wage pressure normally required to push inflation higher. Further, the European Central Bank, the most hawkish of the big central banks, surprised the market this month by virtually ruling out a rate rise for June, in another sign that fear of overheating had started to recede. Such a picture is also confirmed by the implicit inflation expectations generated by the bond market.
Of course, this can be viewed in two ways. While many will be happy that inflation is not imminently going to swamp the world, it is worrying that the main reason for this is a lack of economic growth.
As for oil, fears that the Arab Spring, and the conflagration in Libya, would interrupt crude oil production helped push up prices this year, and the market has subsequently calmed down. That seems to explain price moves so far this year, which have seen a menacing surge followed by a correction.
Agricultural and industrial commodities, however, are more concerning. Base metals, according to Dow Jones-UBS indices, peaked this year. They are now 11 per cent below that peak, no higher than they were six months ago, and trading below 50-day and 100-day moving averages of their price. If metals prices are a gauge of sentiment towards the economy, then this is strong evidence that sentiment has topped and is now declining.
The Dow Jones-UBS index for agricultural commodities is similar. Again, the index has oscillated aimlessly for the year and is about 10 per cent below its high.
More concerning, take a look at lumber futures, which are less of a speculative vehicle because they are not included in the traded indices and are harder to buy. They should, however, be a decent gauge of where suppliers believe the US construction industry is heading. If so, the story they tell is disquieting: they have dropped more than 30 per cent this year.
All this matters because of linkages with other markets. The correlation between commodities and equities, at least at a global level, continues to be almost ironclad. Chart the FTSE-All World stock index and the Dow Jones-UBS industrial metals index on the same graph and it is hard to tell the difference. There is no reason that this should always be so. Higher commodity prices mean higher revenues for some but equally higher costs for someone else, so there is no necessary relationship.
Over history, periods of strong upswings in commodity prices have tended to coexist with flat performances for shares. So a simple top-down view of the world where commodity prices are deemed to be leading indicators of global economic growth still predominates. That has the unwelcome implication that the trouble in commodities implies problems for other markets and for the economy. And the spate of mini-bubbles in asset prices – visible in recent internet stock offerings in New York as much as in silver – implies that investors are finding it ever harder to make money and are getting a little desperate.