Commodities are struggling, and that’s not good for Canadian investors or for anyone who has tapped into the argument that a commodities “super cycle” – driven largely by surging demand in China – would maintain upward pressure on prices for raw materials for a long, long time.
The Reuters/Jefferies CRB index of 19 commodities has slumped a total of 22 per cent since April 2011, conforming to the popular definition of a bear market. It is now at its lowest level since October 2010. Few items in the index have been spared from the recent selloff: Crude oil has fallen 17 per cent from its high, copper has fallen 22 per cent, cotton has fallen 32 per cent and nickel has fallen 41 per cent.
For all of the uncertainty about Europe’s economy right now, the blame rests primarily with the two biggest commodity consumers: China and the United States. And in both cases, the economic news has hardly been upbeat. U.S. employment gains have been shockingly slow, failing to make much headway into the millions of jobs lost during the recession.
And in China, the concerns revolve around signs of slowing economic growth. In the latest, a government report on industrial production showed growth at its slowest pace in three years, amid slower-than-expected retail sales and slowing export growth.
Authorities have responded by lowering the amount of money Chinese banks must hold in reserve – effectively releasing a pile of cash into the economy – but economists nonetheless are dimming their views on overall Chinese economic growth. According to Bloomberg News, JPMorgan trimmed its full-year forecast for economic growth to 8 per cent from 8.2 per cent, and Citigroup reduced its forecast to 8.1 per cent from 8.4 per cent.
Meanwhile, China’s thirst for energy doesn’t appear to be rising at a breakneck pace any more. According to the Bank of Nova Scotia, petroleum consumption in China rose just 6.3 per cent in 2011, down sharply from a 12 per cent gain in 2010.
To be sure, commodity prices have taken their share of hits since 1999 – which is seen as the starting point for the bull market, given that is roughly when China’s economy really started to open up. In 2001, the CRB index fell 28 per cent; in 2006 it fell 20 per cent; and in 2008 and 2009 it plummeted 57 per cent.
However, those declines were mostly due to a sudden drop-off in demand, due to economic stumbles. Now, in addition to the latest economic-driven concerns about demand, there are rising concerns that supply is also affecting prices – as in, supply has risen sharply as companies have strived to produce more to meet demand. In a Wall Street Journal article about commodities, the newspaper noted that crude oil output has risen 16 per cent since 1999, copper output has risen 28 per cent and aluminum output has risen 94 per cent.
The market might not be able to absorb all of this extra stuff right now, creating a glut that will continue to weigh on commodity prices. That is having a big impact on Canada’s S&P/TSX composite index, where commodities have close to a 50 per cent weighting. This year, the index is down 3.4 per cent, versus a 7 per cent gain for the S&P 500.
Does that mean the commodities “super-cycle” is over? Not really. But it does mean that the ride remains anything but smooth.