When the financial crisis torpedoed the global markets in 2008, commodities sunk like anchors, none more so than oil. In little more than half a year, prices went from about $144 (U.S.) a barrel to about $40 a barrel – a 70-per-cent fall.
Three years later, commodities have been getting the crunch treatment again as the euro zone debt crisis spun out of control and talk of another recession spewed from the lips of assorted economists and doomsayers. Since the spring, prices have fallen roughly in line with the equity markets. Mining shares have been slaughtered. Xstrata, to name but one biggie, has lost a third of its value in six months.
And oil? It, too, has fallen, but by less than you might have imagined. According to the BP Statistical Review, prices for Brent crude (the de facto global benchmark) climbed to about $124 by March, dipped ever so briefly below $100, and then recovered with alacrity. On Friday, the price was about $114. To be sure, oil shares are down, but by far less than those of the rock variety. In half a year, Exxon Mobil has lost a mere 8 per cent.
Has oil broken from the commodities pack?
For commodities in general, the question is whether the selloff was triggered by the global economic slowdown or a rush to the exits by the hot-money or “speculative” crowd. No doubt both, which is not a very helpful explanation. The better question, perhaps, is whether the long-term downward price trend in commodities has changed. If it hasn’t, and commodities revert to their mean, then – watch out – the selloff might be in its infant stage.
Jeremy Grantham, fund manager at GMO and clever bubble spotter, has noted that commodity prices over all declined in real terms by about 1 per cent a year in the 20th century. In the past decade, however, prices went almost straight up, reversing a hundred years of losses and turning mining companies into some of the world’s most valuable stock market players. Mr. Grantham noted earlier this year that commodities ranging from cotton to iron are massively higher than their long-term trend.
As Marshall Auerback, global strategist at hedge fund Madison Street Partners said in a recent note, “the departure of real commodity prices from their mean has been so great that Grantham suggests there is a prospect for a significant correction,” and that any such correction “will be amplified by speculation and will develop bubble-like overshooting.”
Translation: The commodities “correction” we’ve seen so far could be the start of an ugly selloff that might take prices to unrealistically cheap levels.
Which brings us to oil. Its price too is considerably higher than the long-term trend, even though it’s well off its 2008 peak. So is oil poised to shred your commodities portfolio?
Don’t count on it. Not all commodities are created equally. The fundamentals are working in its favour. We might all be bored to death with the China story, but its oil consumption growth is off the charts. China is gulping about nine million barrels a day, up from seven million only five years ago. The more impressive figure is consumption per capita, which has climbed 350 per cent since the early 1980s and will keep rising (consumption per capita in the United States and in much of Europe is falling).
There is no reasonably priced substitute for oil in spite of the sinful billions thrown at the renewable fuels industry, from solar power to corn-based ethanol. The rise of resource nationalism is making it increasingly hard for the most efficient commercial oil producers, such as Exxon Mobil and BP, to gain access to the easy-to-produce reserves. So they are forced to go into highly risky areas, such as the Arctic or the deep bits of the ocean. That huge expense has to be factored into the price.
Yet another factor is the strong economic and population growth in oil-producing countries. Take Egypt, whose population has gone to 80 million from 20 million since the 1950s. In 2009, its oil exports declined 26 per cent, for the simple reason that the oil is needed at home.
The oil analysts at Barclays Capital in London think a global oil supply deficit is the big, underplayed energy theme, underplayed because the markets seem to be (wrongly) obsessed with the global economic slowdown. In a September note, they said “There is a large supply deficit in the global oil market, with demand having significantly exceeded supply in [the third quarter]”
Oil prices could fall, in keeping with the theory that they’ve strayed too far from their long-term average. But any pullback could be a gorgeous buying opportunity. If Barclays is right, scarcity value, not a century-long trend, is bound to propel the price.