On Sunday we highlighted the rather shocking fact that commodities prices (as measured by Bloomberg’s commodity index) recently hit their lowest levels of the 21st century [12].
There are a number of factors that explain the plunge, not the least of which is slowing demand from China (as reinforced by this month’s beggar thy neighbor yuan deval which telegraphed Beijing’s worries about the domestic economy) and a global deflationary supply glut across the space exacerbated by easy access to capital markets (which allows otherwise insolvent producers to continue to drill, dig, and pump despite lackluster demand), and Saudi Arabia, which has embarked on an epic quest to bankrupt the US shale complex by keeping crude prices at multi-year lows.
The effect has been to put enormous pressure on emerging economies - pressure which the yuan devaluation only exacerbated.
Against this backdrop, we bring you the following graphic from Citi which breaks down the best and worst performing commodities both YTD and QTD.
[13]
Additional color, from Citi:
Commodities have both reflected and promoted deflationary trends over the course of 2015. The main commodity indices – the BCOM and GSCI – are trading at or near the same level they were at prior to the so-called commodity super-cycle period of 2003-2008. Much of the lost value in individual commodities came not just over the course of 2015 but during the first month of the current quarter (see figures below).
Perhaps the most critical factor has been commodity over-supply. And yes it is true that lower demand has played a role in a world with stagnating growth, especially in emerging markets. But high prices in the last decade prompted a frenzy of capex spending to unearth larger quantities of raw materials. As is more often than not the case in commodities markets, the result of over-investment was over-supply, which traditionally hovers over markets for years.
Among the many additional factors leading to lower commodity prices has been tremendous cost inflation across most commodities in the first decade of this century, but especially in those like oil, natural gas and iron ore where higher prices triggered a search for new raw materials which led to new discoveries in the mining sector, particularly in the case of iron ore. It also led to the development of new technologies that opened up the commercial exploitation of resources that had previously been too expensive, as in the case of shale gas and oil. Lower cost new supplies traditionally compete with higher cost older supply at a late stage in the investment cycle. Recently discovered lower cost supplies can in many cases linger and impact markets for the rest of this decade if not beyond.
But a host of other factors have been at work, including producer nation currency depreciation as well as the impacts of quantitative easing by central banks across the world. Recent commodity price declines have created a sort of self-fulfilling situation for commodity exporting countries. They have experienced currency depreciation, which in turn reduced even further the costs of raw material exploitation around the world, whether for gold in South Africa, or iron ore in Australia and Brazil, or oil and gas in the case of Russia. Weaker currencies also made wheat exports more competitive from the Black Sea and Latin America as compared to US supplies, thereby pressuring benchmark prices. These factors also prolong and exacerbate the supply overhang by lowering local production costs.