Unlike the business cycle, which tends to complete a full rotation every six years on average, commodities follow their own pattern which can last well over a decade. Since 1894, there have been four recorded commodity super cycles, with the last one beginning in 1999 and peaking in 2010. Excluding oil, which operates separately due to strict control over supply by organizations like OPEC, the real prices of all commodities tend to move together, with their peaks correlating with the peak of the global economy.
But commodities have fallen far from the highs they previously held and don’t appear to have any positive catalysts to propel them higher. They seem to be stuck and there are many forces at work holding them at bay.
Commodities move inversely relative to most other asset classes. The relationships work as follows: currencies up, commodities down, bond prices up (yields down), and equities up. And of course it works the same in reverse. Commodities tend to do well in environments of high inflation which eat away at the value of the dollar and negatively impact equities. Equities require a higher rate of return in order to keep up with inflation.
Since inflation has remained stubbornly low, commodities haven’t been an attractive asset class. Other assets, like stocks, offer better returns. But there are many bearish signals in the financial markets right now and inflation is slowly beginning to pick up. As such, commodities should be facing a resurgence, but they have an uphill battle ahead.
The dollar and commodity prices are probably one of the most inversely correlated relationships in the market. It makes sense that commodities have suffered lately given the kind of strength we’ve seen in the U.S. dollar, and it doesn’t look like that’s going to change anytime soon. The Fed could be raising interest rates soon which will only further bolster the dollar’s strength. Compounding the problem is the fact that the central banks of China, Europe, and Japan are all engaged in monetary stimulus plans, actively devaluing their own currencies which, by default, helps lift the dollar’s value.
Regardless of whether stocks begin to fall, commodities will have to break through the barrier of having a strong dollar on the market which is generally seen as a safe-haven asset over commodities. Inflation will be the only way to break free of the dollar’s dominance, but it could be a while before we see that effect have any impact on the global marketplace.
For the past decade or so, China has been the de facto world leader for commodity demand. Heavy imports of aluminum, steel, and copper laid the foundation for a fast-growing infrastructure base.
With the lion’s share of the worlds commodity production meeting China’s insatiable demand, a bubble might have been created that suddenly burst when China began reporting decelerating growth, and again when the Chinese stock market crashed.
As a global slowdown looms, other commodities like oil have fallen and don’t seem set to recover in the near future. Food prices have also declined as inflation has stagnated, creating a tough environment for agricultural commodities as well.
The Bottom Line
The end of the commodity super cycle has dragged prices down, in some cases by as much as 80% off their previous highs. Inflation is the biggest threat to a commodity comeback and if a global slowdown does happen, commodities may not make much of a headway while the dollar remains high.
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