Edward Meir is a senior commodity analyst at MF Global, the world’s
leading broker of exchange-listed futures and options. Meir’s position
affords him a unique window onto the commodities markets, as he is able
to see how and where money is flowing into and out of the market. He
spoke recently with HardAssetsInvestor.com.
HardAssetsInvestor.com [HAI]: What impact would a U.S. recession have on the commodities market, if that comes to pass?
Edward Meir [Meir]: The jury is out on that. If you look at what has happened historically, commodities do not perform well in a recession. We think that if we do get a U.S. recession, it will spread quickly overseas. There are already signs that that is happening: Europe’s economy is slow, Japan is slowing down, and even Chinese growth will probably be lower this year than it was in 2008, partly due to their efforts to nudge up the currency, tighten credits, and more.
If you put that whole package together, you’ll see a reasonable shift
downwards in metals demand, which correlates highly with industrial
production growth. If you get a scaling down from a recession, metals
and energy should suffer a bit.
HAI: So a recession equals bad news for commodity investors?
Meir: Well, the arguments going against that are the weaker dollar, which acts as a prop for commodities. Also, the fact that you have so much index money going into commodities pushes them up. It’s now so easy to access commodities with ETFs; you don’t have to open a futures account or have anything. You can just buy an ETF.
Still, I think that if we get a global slowdown, commodities will suffer. You can’t fight a slowdown in growth just with the dollar or the index flows. People will either stop buying into commodities or they will go short. The growth picture is the big thing to watch, and it has been casting a pall over the sector for the past few weeks.
HAI: How big a role are the index assets having?
Meir: Before all this index money came into the
picture, many of these commodities futures were used for hedging by
commercial producers. Now, you’re getting a wave of index and CTA
[commodity trading advisor] money that is pushing everything higher.
These are speculators, and they have effectively pushed up the trading
ranges on the commodities much higher than they were in the past.
Copper was just as tight in 1980 or 1970 as it is today, but prices were one-sixth of what they are today. The way you explain that is that the index money is exaggerating things.
HAI: Does that make the market riskier?
Meir: Certainly, these guys operate like a herd: They can swing out of the market just as quickly as they swung in. We’ve seen it happen many other times.
The big shoe to drop – the one that everybody is watching and waiting on – is China. China is starting to slow, but so far, oil and metals demand is still strong. We haven’t seen their demand buckle yet, but if it does…
HAI: So do you believe in the commodities supercycle, or is the bull market over?
Meir: I think we’re still in a bit of a supercycle. I think we’ll have a sizable correction in 2008, and then another leg higher in 2009.
HAI: Long term, though, you’re bullish on the space?
Meir: Yes, but it does worry me that everything is now interrelated. When things go bad, they tend to spread across the globe. If we get a sharp slowdown here, it will impact Europe and China. Despite what people say, I don’t think China is immune to a U.S. slowdown. We feed them $200 billion a year, our consumption is nine times theirs, our GDP is four times as large. They haven’t displaced us as the economic engine of the world.
If we slow down, and Europe slows down, I don’t see the supercycle continuing. That’s the problem I have with commodities bulls. They’re looking at everything through the China prism, but China is not a stand-alone entity. And they have problems … big problems with the environment, with labor, with migration and with the dichotomy of an extreme capitalism supervised by a Communist party system. It is not a stable picture.
I don’t know what’s going to happen here, but something has to give. The days of plowing a superhighway through a town by fiat might be over. People are staging demonstrations. China has got to come to terms with the next cycle of their advancement, which means addressing labor issues, health issues, legal issues like IP. All of these things will come home to roost for China over the next three-to-four years.
HAI: You think the Chinese economy could be in trouble?
Meir: No one is talking about a recession in China, but it could happen. They’re building a lot of real estate; the stock market is wild; the government is tightening their currency. They could slip, if not into negative growth, then into a slowdown. They’re not immune from economic cycles just because they’re China and a Communist state.
HAI: With that in mind, if you were a retail investor looking at commodities, what would you do?
Meir: I would scale back on commodities exposure in 2008, because we’re heading into a slowdown. I would keep some gold exposure as a hedge against the dollar.
I think we’re in a “V”–shaped trajectory. I think we'll drift lower in 2008, and then, as the stimulus package and the interest rate cuts kick in in late-2008, you might see demand start to push higher again in some of these commodities … towards another spike in 2009.
The big question for 2009 is, will the energy markets start to discount
the possibility of a new administration pulling U.S. troops out of
Iraq. If there are signs of that happening, that would be quite bullish
for the energy markets, because I think then that place will go up in
Iraq is a big problem. Americans will have to leave eventually. The question becomes, will these guys hold anything together. I’m not sure they can.
Ironically, Iraq has been one of the main suppliers that have been boosting production over the past few months. They’re doing pretty well right now.
HAI: What about the prospects for other commodities, like gold? How will that hold up in a recession?
Meir: I don’t think anybody follows gold based on supply and demand. Gold is viewed as an inflation hedge and as a weak dollar play, an anti-inflation play. With the U.S. deficit going out of control and the Fed continuing to lower rates, the big casualty is going to be the dollar. As people lose faith in the purchasing power of the dollar, they are going to want to buy something that will retain its purchasing power.
Gold is still undervalued. There are a lot of studies that show that if you take crude oil prices in 1980 and adjust them for inflation, it should cost about $102/barrel. Similarly, if you do the same thing for gold, it should cost $2,500. So we are still quite bullish on gold. I think it will do well over the course of the year. It stands apart from other commodities that have more of an industrial punch, which can suffer if growth suffers. Gold will be immune to that.
HAI: Thanks, Ed, for your time.