Has Commodity Pessimism Become Self-Fulfilling?
Right now, whoever drives the argument also drives the market.
Ruchir Sharma, head of emerging markets equities at Morgan Stanley (NYSE:MS) Asset Management, helped popularize this concept when raw materials prices were being pummeled last spring. He peered 200 years into the past and divined a persistent pattern of decade-long rises in commodities values followed by 20-year periods of decline.
The boisterous up decade of the 2000s (the little glitch of 2008 excepted) has now ended as its driving engine, China, shifts to less resource-intensive growth and its BRIC cousins sputter in general, Sharma argued. Investors who had flocked into commodities ETFs in recent years had better sell and wait for the next historic upturn, due in about 2030.
Sharma’s thesis has reemerged lately as analysts try to explain a curious phenomenon: The outlook for raw materials consumption has brightened considerably over the past six months or so, yet commodity prices remain lackluster. America is building houses again. China is erecting new cities powered by a $150 billion state infrastructure stimulus. Japan is loosening the spending taps. Europe is off the ropes for the moment.
Yet commodities are stubbornly underperforming. The popular iPath Dow Jones-UBS Commodity Index Total Return ETN (NYSEARCA:DJP), for instance, has lost value over the past half year, while the S&P 500 (INDEXSP:.INX) gauge of stocks skipped ahead by 7.5%. Oil has been on a nice run since mid-December, spurred at least partly by one-off factors like the gas rig hostage crisis in Algeria. But that comes after a flaccid autumn for crude prices. Taking a six-month time horizon, the market-dominating United States Oil Fund (NYSEARCA:USO) has also lost ground.
Will investors’ preference for “risk-on” equities over risk-on commodities last? To answer this question, the heavy hitters of world finance have been weighing in for or against Sharma’s end-of-supercycle prediction. Citigroup (NYSE:C) backed its colleague from Morgan Stanley. Goldman Sachs (NYSE:GS) and Commerzbank (ETR:CBK) begged to differ, predicting that demand will raise prices in a normal way, provided the current global upturn continues.
Underlying supply-demand trends do point to softer prices going forward for oil. For metals, not so much. Driving the world oil equation is both increased output and decreased consumption by the planet’s energy glutton, the good old USA. Domestic crude production rose by 800,000 barrels per day last year and should surge by an additional 1.5 million by 2015, according to the US Energy Information Administration.
That extra 2.3 million barrels over three years is equal to about 3% of global oil output, a significant jolt to such a tightly balanced market. America, meanwhile, reduced liquid fuel consumption by more than 10% over the seven-year period from 2005 to 2012, EIA reports, as more of us junked our SUVs or switched to gas heat at home.
For copper, the bellwether base metal, the outlook is at first glance more bullish. Global consumption has outpaced production for three years running, according to the International Copper Study Group. One reason prices have been subdued is that China, which consumes fully 40% of the world’s industrial metals, massively overbought last spring just as its economy was cooling, and now has inventory to work through. Eventually it will, and need to buy more.
But beyond these fundamental issues, there is some evidence that commodities are lagging because Mr. Sharma is winning the intellectual argument and pushing them out of fashion. As one European fund manager told Reuters the other day: "This year we have seen quite a lot of banks having their first-quarter review, and for the first time some of them are wondering if the bull market seen in some commodities is over."
So the idea that the super-cycle is over may lead to the super-cycle being over? Maybe, sort of. In any case, it is useful to compare commodity funds with mining company stocks, which have been delivering the healthy returns you would expect in the current macroeconomic climate. Bloomberg’s World Mining Index of equities has outperformed the S&P over the past six months with an 8.5% advance.
Given that prevailing prejudice toward equities, investors might want to look at mining fixtures Rio Tinto (NYSE:RIO) or Anglo American (PINK:AAUKY). Both stocks have been walloped lately by botched projects that led to big write-downs, and could be poised to recover.
Keep an eye on copper, too.
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