The last two years have been terrible — that’s an understatement — for commodities.
Since the start of 2014, the average landed cost of crude imported by Indian refiners has fallen from $ 108.76 to $ 36.65 a barrel. The same period has seen the London Metal Exchange Index that tracks prices of six primary non-ferrous metals — aluminium, copper, zinc, lead, nickel and tin — shed nearly a third of its value, even as benchmark US Midwest hot rolled coil steel rates have collapsed from around $ 680 to $ 365 per tonne.
But it’s not just energy and industrial metals. The same holds true for precious metals and agricultural commodities. Gold on Friday traded in London at $ 1,072.5 per ounce, compared to $ 1,225 in early 2014, and the peak of $ 1,895 reached on September 5, 2011. The UN Food and Agriculture Organisation’s food price index, at 156.7 in November, is also down from its December 2013 level of 206.2, and the all-time-high of 237.7 for February 2011.
There are broadly three reasons for this commodity meltdown, of which two are relatively easy to understand.
The first, of course, is China. The slowdown in the world’s largest manufacturing economy has hit demand for everything from copper, nickel and aluminium to coal and iron ore. Given its share of global consumption, ranging between 50% and 75% in these industrial raw materials, the dragon sneezing has naturally led to Brazil, Australia, Indonesia, Chile and many others catching cold. Worse, the excess steelmaking and aluminium, zinc and copper smelting/refining capacities that came up during the boom have today become a source of dumping, as Chinese producers are increasingly pushing overseas sales to offset stalling local demand growth.
The second is a strengthening US economy, alongside its emergence as a surplus oil producer, courtesy the shale revolution. In October 2013, US crude oil output hit 7.7 million barrels per day (mbpd), surpassing imports of 7.5 mbpd. Since then, its production has gone up further to an average of 9.4 mbpd, while imports have hovered at 7.3-7.4 mbpd. This turnaround in fortunes for a country that consumes a fifth of the world’s oil — in addition to the current hype over solar and wind energy, amidst growing pressure for phasing out fossil fuels — has been a significant contributor to the tumbling of crude prices. Simultaneously, the US economic recovery and the prospect of an imminent Federal Reserve interest rate hike have fostered a strong dollar, in turn, diminishing gold’s safe-haven appeal.
The third factor is somewhat more complex, having to do with commodities being lumped together as a distinct ‘asset class’. From the early 2000s, commodities became trading vehicles for not just chocolate manufacturers, jewellers or airline companies wanting to hedge against volatility in prices of cocoa beans, bullion or fuel, but even for exchange-traded funds and other ‘pure’ investors having no direct production or dealing interests in them. At the height of the so-called emerging markets boom, the notional value of net ‘long’ or bullish investments in commodity index products monitored by the US Commodity Futures Trading Commission (USCFTC) totaled $ 256 billion in end-April 2011.
That tide has turned in the past two years, though, as index, pension and hedge funds have sharply cut their commodity exposures — the last USCFTC data for October 30 shows net long index positions at only $ 138.3 billion. The mounting selling pressure from funds has aggravated the crisis in commodity markets and also for governments, whether in Russia and Brazil or Argentina and Venezuela (where recent elections have seen seemingly secure socialist regimes being dislodged). Even the apparent rural backlash being faced by the Narendra Modi dispensation can be traced quite a bit to the global commodity crash affecting realisations for sugarcane, cotton, rubber, rice, soyabean or milk producers in India as well.
While the meltdown has impacted commodities across the board, the idea that they can be lumped together as an asset class could, nevertheless, come under challenge in the months ahead. The one distinction that markets may well end up making is between commodities whose prices in the near- to medium-term are largely a function of demand, and those for whom there could be supply-side issues, too. In the former category would be energy, base metals or gold and silver whose production is not amenable to sudden increases or decreases. It’s safe to assume that their prices would remain under pressure, so long as the Chinese slowdown continues and India does not provide the new fuel for global growth that Modi’s election initially promised.
Agricultural commodities fall in the latter category. In their case — at least for food, even if not for cotton, guar-gum or bio-ethanol — demand is stable or unchanging at worst. At the same time, supply is more prone to fluctuations, in response to both weather conditions as well as prices: it may be easier for farmers to expand or contract wheat acreages from season to season than for BHP Billiton, Rio Tinto, Glencore and Vale to open and shut down mines.
It is for this reason that the effects of the current El Niño — already the strongest since 1997-98 and expected to last through the winter and early spring — on the supply of farm produce cannot be written off. In the last three months, global prices of palm oil and sugar have climbed by 12.5% and 25% respectively, while cocoa futures are ruling 17.5 per cent higher over last year at this time. Dry weather in Indonesia, Australia, West Africa and India is clearly causing supply concerns at least in these commodities.
The world may still be awash in corn, wheat and soyabean, but we still aren’t sure about the extent of drop in rabi plantings and the likely moisture stress to the already-sown crop in India. By the time the picture becomes clearer towards January-end or so, the markets may start treating agricultural commodities a little differently from the other constituents of a generic, undifferentiated ‘asset class’.