Is the Bull Run in Commodities Over?

Recent days have seen an intense debate on the hot topic of the year — commodity prices. We have seen commodities across the board tumble in the past few months. Pessimists have started writing obituaries for the commodity bull and pronounced an end to the ascent in commodity prices. The scale of the rout can be seen in the Reuters-Jefferies CRB index, a basket of 19 commodities, which has fallen below 400 points to its lowest level since early April, a drop of about 14 percent since a record peak above 473 in early July.

So is the commodity supply/demand squeeze over?

Investors have retreated from the commodity markets on fears that economic slowdown in the United States has infected growth in the rest of the world, worries that demand growth will collapse and a rising dollar.

The global economy has been showing signs of demand destruction as a direct response to high commodity prices, especially crude oil. If recently released statistics are to be believed, Americans are driving lesser number of miles, buying fewer cars (especially gas guzzling SUVs) and are shifting to mass transport systems like railroads and buses, away from expensive modes like airlines. Globally, oil consumption is also expected to grow slightly in 2008 year by 760,000 barrels per day to an average of 86.8 million barrels. This is the weakest global growth rate since 2002. Due to a cyclical slowdown in world economy, not only in North America but also in OECD Europe and Pacific, oil demand will be weak in 2008, as well as in early 2009. Japan is also showing signs of reduced pace of economic activity.

The debate over whether the “Commodity Super Cycle” is dead or alive also revolves on whether the U.S.-dollar has hit rock bottom against the Euro and other foreign currencies. A stronger U.S.-dollar creates a virtuous circle of knocking commodity markets lower. In August, the dollar rose versus all of the other major currencies this on concern the economic slowdown that began in the U.S. is spreading to the rest of the world. The dollar gained 6.4 percent versus the euro, the best performance since the European currency's debut.

Commodity prices will fall, because they always do. A fundamental truth of commodities is that they fluctuate about a mean. If demand exceeds supply, ultimately a new mine opens and supply then exceeds demand.

What is being ignored is the fact that, although Demand has slackened, supply remains tight. When it comes to oil, non-demand from OECD, Asia and the Middle East still remains strong. Soaring oil prices have not slowed China's consumption of oil as statistics show that China's apparent consumption of crude oil and refined oil products both hit record highs in the first quarter of the year. There are talks of slowdown in Chinese economy and demand for commodities post Olympics. However, we are yet to see any convincing evidence of such a halt in Chinese economic growth. Moreover, Chinese government has recently announced a fiscal stimulus, which is expected to keep the Chinese economy from slipping into a post games slowdown and by extension, the global economy going.

In addition, though OPEC supply has been increasing over the past few months, Non-OPEC supply remains a big problem. Production is declining quickly in Mexico and Russia as well as Britain North Sea Oilfields. Already, with each passing day, OPEC’s spare capacity is moving southward. Moreover, the geopolitical situation remains volatile, and still threatens to send commodities prices once again over the roofs.

The same situation applies for the base metals complex. There seems to be no end to the China’s appetite for copper. Supply remains tight due to production disruption in Chile, Mexico and Peru, the leading producers. Precious metals are also expected to rule at comfortable level as the global economies reel under inflationary pressure. Given the strong demand supply mismatch, possibility of a crash in prices of agricultural commodities also seems far-fetched. Rising global population has led to an upsurge in demand while at the same time acreage has gone down significantly. Moreover, inventories of food are touching all time low.

Mark Mobious, the renowned investment Guru said:

When you have a long-term uptrend, excesses build up along the way. We are witnessing a correction. Demand for commodities will remain at a high level in countries like China and India. If we see a serious worldwide recession, then we will see the end of the commodities boom.

Therefore, in retrospect, it seems pertinent that a bull run in commodity markets remains intact. What we are witnessing is a corrective reaction to an unusual run up in prices within a framework of a long-term bull market in commodities. Bull markets in commodities last as much as 15-20 years or even more. There may be periods of large correction that may witness a fall of as much as 40%.

Although prices may cool in near term due to demand destruction and a stronger dollar, over the longer term, price is expected to be largely influenced by fundamentals intrinsic to commodities. Corrections are inevitable in any uptrend and the commodities market is no exception. The long-term fundamentals dictate that any major corrections remain buying opportunities for long-term investors.

Comments

[buyitcheap:]

As the dollar strengthens, and other countries cut rates, commodities will continue to fall.

2008 Sep 02 09:08 AM

[mangolfer:]

It was not an uptrend, it was a bubble and it burst.

2008 Sep 02 09:13 AM

[phdinsuntan...:]

Mexico and Peru, the leading producers? this is plain ignorance

2008 Sep 02 09:19 AM

[icandoitdon:]

"what we are witnessing is a corrective reaction to an unusual run-up in prices."

yes, that's called a speculative bubble, as i've posted many times before. throughout 2008 oil has not traded as a commody...it has traded as a financial derivative. that trade is over, killed by a softening world economy. as for china and india, hello??? a softening world economy affects them too.

notice that deafening silence from all the morons who claimed that speculation wasn't a factor in oil prices.

2008 Sep 02 09:51 AM

[Roowns:]

My opinion is that currently it's a downtrend in oil with small uptrends on the way like the one we had in the past 2 weeks or so.
I expected oil to drop a lot more faster, but today with -7% or so it confirmed my theory.
Still I don't see stock market to perform after this is over. It's more like a confirmation of global recessionary impact.

2008 Sep 02 12:20 PM

[epeon:]

In general, I do not see the commodity prices as a bubble. This is because underpining the commodity businesses is very solid revenue and earnings. The oil majors are at a pe of under 10. Copper producers, coal miners, etc. all have very solid earnings and pay good dividends. Commodity prices are still historically high.

A bubble is like the high-tech bubble where companies have pe ratios greater then 30 or, in many cases, no earnings at all. So, is a correction in commidity companies possible. Sure, but it will only be a correction.

2008 Sep 02 01:23 PM

[Sober Realist:]

Out of all these posts, why is it that epeon is the only one that gets it?

2008 Sep 02 03:56 PM

[icandoitdon:]

for those who think they get it, consider the following:

commody stocks having "solid revenues and earnings" has utterly nothing to do with price bubbles in the underlying commodity. at today's levels, about 20% off the may peak, oil is still nearly double the price of last year while XOM is down almost 10%. if the market believed peak oil prices were sustainable, XOM would not be down 10% and selling at under10x trailing earnings....it is selling at 10x trailing earnings precisely because the market believes those are peak earnings, not sustainable in a softening world economy.

oil is just one example of commodity stocks that have historically sold at modest p/e's because they're cyclical businesses. such businesses do not and should not command premium multiples. neither will they strongly correlate with the underlying price of the commodity, which is extremely volatile.

the bubble in technology is not remotely comparable to the bubble in world oil prices. oil has known supply/demand characteristics. high prices create demand destruction, which we're now seeing...china and india notwithstanding. oil prices will always revert to an equilibrium price based on supply/demand fundamentals. but that doesn't mean that bubbles can't periodically surface any more than it means that price can't periodically collapse. both have happened in the past and both will happen in the future. we've seen a quadrupling of oil prices in the last 4 years or so, which is historically unusual (i.e. a bubble) but not unprecedented. those who believe that the days of $40 oil "are gone forever" are simply ignorant of both markets and history. that includes general motors, goldman sachs, boone pickens, and others with short memories.

epeon's comment that commodity prices are "still historically high" despite a slowing world economy speaks for itself. look for further declines if the world economy continues to weaken.

2008 Sep 02 05:41 PM

[Sober Realist:]

XOM is down because they are not investing much in oil exploration, spending their money on share buy-backs instead. In the last quarter, all of the Western oil majors, including Exxon Mobil, said their oil output had declined by a total of 614,000 barrels a day, even as they posted $44 billion in profits. It was the steepest of five consecutive quarters of declines. The Western oil majors have been and are being squeezed out of areas like Russia and Venezuela by the NOC's. The Western majors now only account for something like 7% of the world's oil reserves. It's a fact that fifty-four of the 65 oil-producing nations have entered irreversible production declines. The oil industry, too, is suffering from shortages of equipment and engineers. Even worse, all of the countries best equipped to pump more of the stuff are members of the Organisation of the Petroleum Exporting Countries (OPEC). And we know they are keenly aware of the price drop and don't want another price collapse like in years past. We have been on a plateau in oil production since mid 2004. The easy, high-yield oil has been expended. These are all cold, hard facts. Obviously a slow down in the world economy will lower price temporarily, but unless you expect the entire world oil consumption to continue shrinking indefinitely, prices will rebound at some point. The market will find the fair price for oil. Is world population shrinking? Some 80,000,000 more people are added to the world population every year. In North America alone, each individual consumes food annually that takes an average of 400 gallons of petroleum to produce. Is the 3,000 mile cesar salad still here? Yes it is. Are we all starting to live like the Amish with horse-drawn buggies? No. The best way to try and preserve our car society is to improve gas efficiency like the Europeans have done. Are the fundamentals behind commodities still firmly rooted? Yes.

2008 Sep 02 07:37 PM

[John C. Lee:]

epeon - every asset class or market experiences bubbles. Human nature is all the same. Tech was not the only bubble in history, recall the tulip mania, south sea, mississippi co., Florida land, comic books, beanie babies, etc...Commodities are no different.

2008 Sep 02 08:01 PM

[John C. Lee:]

oh yea, and that whole CROX craze

2008 Sep 02 08:02 PM

[Sober Realist:]

Weekly TA,
Comparing oil, food, metals, and other commodities to things like comic books, beanie babies, tulip mania, the south sea shipping co., etc is fundamentally wrong. Last time I checked, a beanie baby and comic books were not essential to our economy and life. Nice try.

2008 Sep 02 09:37 PM

[User 143167:]

If people are right about global recession which will send oil price below $80, the DOW will be below 8000 too.

Without a major growth in oil outputs, Oil down and DOW up is beyond any logics.

2008 Sep 02 11:14 PM

[Sober Realist:]

That's right. Oil output down and Dow up makes no sense. As one geologist said to me, we better start drilling or we might as well turn our economy over to the NOC's.

2008 Sep 02 11:36 PM

[John C. Lee:]

Realsit - all were bubbles and were created by excessive demand which was my only point. You may not know this, but bubbles occur in every market. You don't think the run up in commodities was caused by speculation? Everything I mentioned = speculation = bubbles. Commodities are not immune if the thousands of years of history have taught me (and maybe you). It's human nature, and its been around longer than you and I.

2008 Sep 03 01:25 AM

[David Lentz:]

"A fundamental truth of commodities is that they fluctuate about a mean. If demand exceeds supply, ultimately a new mine opens and supply then exceeds demand."

But what about the demand side of the equation? Sure, it's a bit depressed at the moment, but if you look at the global population growth <upload.wikimedia.org/w...;, you can see nothing but increasing demand ratcheting commodity prices ever-higher.

The "mean" that commodity prices fluctuate about is being pulled upward by rocketing population growth. The green revolution and development of antibiotics has created a situation where demand is soaring, at rates far beyond our capabilities to increase supplies to match.

2008 Sep 03 09:45 AM

[yank:]

Everyone wants to talk about a commodities bubble but the key point here is the likely duration of a commodity "supercycle". And as Jim Rogers has pointed out on numerous occasions supplies of commodities continue to "lag" demand. Weekly TA is so fond of pointing out that histroy repeats itself no matter what bubble you are talking about. Well, check your history. All commodity bull cycles have lasted at least 10-12 years, some even longer. We are nowhere near the end of this cycle. The world is not going to come to an end just because some US asshole investment bankers forgot about risk management. The demographics of world commodity demand are simply too powerful to be crushed by the idiocy of a few misguided US investment bankers. The commodity supercycle is alive and well. This is a great buying opportunity for oil, nat gas, fertilizers, coal, copper, and other metals.

Yank

2008 Sep 03 10:44 AM

[Sober Realist:]

WeeklyTA,
Back to the main point. Epeon said: "So, is a correction in commidity companies possible. Sure, but it will only be a correction." His statement is correct. David Lentz also said some well-written points. Sure speculation plays a part in oil price, but not as much as you think. Let me quote our own U.S. Energy Secretary, Sam Bodman:
“Market fundamentals show us that production has not kept pace with growing demand for oil, resulting in increasing prices and increasingly volatile prices.”
“World oil demand has increased significantly in the last few years despite higher prices. China, India, and the Middle East are the largest contributors to this growth as they consume more energy to fuel economic growth."
“While increases in near term oil production are welcome and necessary, fundamentally the market needs to see investment in increasing the longer term production capability... The world faces an extraordinary time that, in my view, demands responsible action from both consuming and producing nations”
I would also like to quote Chris Nelder from an interview last month:
I would emphasize that the way forward is an electrical infrastructure. There are still a lot of missing features. For plug-in hybrids, we need charging stations. For trains, we need the depots, the tracks, and ways to get people back and forth. There are a whole lot of different pieces to the puzzle that need to be put into place, and all of it requires a lot of capital. People need to stop thinking of the dead-end direction of liquid fuels and think about electric. And what about food? What about water? What about shelter? Say we don’t get everything done on time, we don’t get a robust transportation infrastructure, now what do we do about LA? San Francisco? Houston? We can’t support these populations without a lot of continually cheap energy. So I think we’ll have the urban migration in reverse. A lot of people will move back to the heartland where they can grow their food and be near it. I think there will be a revolution in agriculture."
In reality what will happen is that our society will continue to try and preserve the status quo which could prove to be ruinous to America.

2008 Sep 03 10:53 AM

[Sober Realist:]

Yank, I agree with what you just said. There was an excellent interview with Jim Rogers conducted recently that should be read if you want a better understanding of the economy and commodities:
www.financialsense.com...

2008 Sep 03 11:05 AM

[Briggsy:]

Realsit, your urban food observation would seem to make a strong case for hydroponics and the electricity grid.

2008 Sep 03 01:04 PM