By Kurt Cobb
Reading the general run of financial headlines might lead one to believe that price declines in those commodities which are highly sensitive to economic conditions such as iron ore, copper, oil, natural gas, coal, and lumber are good on their face.
Obviously, the declines aren't good for those who sell these commodities. But, those of us who buy these commodities in the form of cars, houses, utility bills and other products and services ought to be helping the world economy as we buy more stuff with the freed up income.
As true as that may be, these commodity price declines also signal something else: exceptional weakness in the world economy. It is no secret that economic growth in Europe has been stalled for some time and is now receding. The European Union's confrontation with Russia over the Ukraine conflict and the resulting tit-for-tat economic sanctions levied by both sides are only worsening the economic climate.
Russia has been hit by the double whammy of oil price declines and sanctions which are probably sending the country into recession. And now the new anti-austerity government in Greece seems to be pushing Europe headlong into another Euro crisis as worries about Greek debt default spread.
Chinese economic growth appears to be faltering. And, that seems to be one of the direct causes of the broad-based commodities price decline. A fast growing China has previously created enormous demand for basic commodities needed to build out its infrastructure--commodities such as copper, iron ore and the petroleum products needed to run all the vehicles and machines essential to that build-out. Chinese demand for basic commodities has also increased as China's expanding wealth has allowed many more people there to own private automobiles and to enjoy other fruits of a spreading consumer society.
Economic distress for China seems to come when its hypercaffeinated annual growth rate falls below 7 percent where it seems to be heading now. Official Chinese statistics have long been suspect, so growth may already be below 7 percent. Lower growth makes it difficult for the country to provide work for all those who are leaving the countryside and streaming into the cities as China industrializes.
Commodity-exporting nations such as Canada, Brazil and Australia have taken a big hit on declining Chinese and world demand. But, their bourses seem surprisingly buoyant given the extent of the damage.
The commodity price declines aren't just confined to the industrial and energy commodities mentioned above. Food commodities have been swooning as well recently. Of course, food prices swing based on farm yields which have no necessary relation to the economy at a particular time. What is especially telling about the decline in the prices of foodstuffs is how broad-based it is.
Price declines affected wheat, corn, soybeans, and oats in part due to record harvests. Prices for cocoa declined due to rising harvests and falling demand. But, not every food commodity is experiencing increased harvests. Sugar production has actually declined in the last growing cycle. Yet, sugar prices fell. At the margin, it seems, people are buying less of what are essentially discretionary food commodities such as cocoa and sugar. Does that seem right if consumer buying power is being buoyed by cheaper industrial and energy commodities?
Stock and bond markets across the world are being levitated by central banks which have telegraphed to investors that the banks will react to practically any weakness in stocks or bonds. Of course, central banks don't much concern themselves with the prices of commodities because they cannot control them directly in the way they manipulate money and credit. That's why commodity prices right now are a much better barometer of the global economy than the world's stock markets.
One could say that the stock markets of the world disagree with the global commodity markets about the direction of the world economy. One could also say that the world's bond markets agree with the commodity markets. Low bond yields typically mean that investors expect inflation and economic growth to be low or even negative. High inflation and/or economic growth tend to cause investors to demand higher yields as credit availability tightens and as concern about inflation eroding bond returns rises.
It is especially telling that in the United States, where the U.S. Federal Reserve Bank ceased its government bond buying program last year (known as quantitative easing), that long-term government bonds returned almost 39 percent, much better than the U.S. stock market which registered a 12 percent gain in the S&P 500 index. With waning support from the U.S. central bank, government bonds were supposed to decline (and yields go up). Just the opposite happened--big time!
And as 2015 began, the consensus was that U.S. (and Canadian) interest rates would rise and thus bond prices would decline. Instead, long-dated U.S. governments--which are very sensitive to interest rate changes--spurted upward another 12 percent in January alone as yields plunged to record lows. This was in perfect concert with the continuing commodity rout suggesting that investors in these markets expect low or no economic growth in the year ahead.
Practically the entire investor class across the world believes that central banks now guarantee stock prices, and that the stock market therefore is a sure thing. Commodities and bonds, however, are telling a contrarian story. The obvious questions are: If central banks are omnipotent, then why didn't they prevent stock market crashes in 2001 and 2008? If it's different this time, what exactly will central banks do to prevent another crash? Can they really effectively lower interest rates which are already at zero in much of the world (and below zero in a few instances)? If central bank policy is so powerful, why haven't six years of the lowest interest rates in memory--and in the case of Great Britain since the beginning of central banking there in 1694--resulted in booming growth across the world?
Last week analyst Doug Noland of Credit Bubble Bulletin fame, summarized the situation this way:
To this point, mounting risks – financial, economic, geopolitical and the like – have been viewed as guaranteeing only greater injections of central bank liquidity.
The assumption has been that if markets falter, central bank liquidity can and will always hurl them higher than before. It seems there is no crisis too big that ever greater liquidity injections cannot solve it. That assumption is already being tested this year, and there are likely to be many more tests coming.
The rather precipitous, alarming and lockstep trends in bond yields and commodity prices in the last year suggest that we are likely to get some clarifying answers in 2015 to the questions listed above.