Conventional wisdom is that the plunge in commodities was due in part to the deflating of a speculative bubble, the balance the result of the nasty contraction now in full force. Once things recover, basic materials should enjoy a strong rebound as China and other emerging markets get back on the growth path. Comparisons to the Great Depression are also encouraging, since commodities rallied before stocks did.
But the optimistic case is not as clear cut as it sounds. Oil bulls point to the unusually steep contango, where futures prices are markedly higher than spot (backwardization is the more normal state of affairs). Traders can now reap attractive risk free profit by buying crude, storing it, and selling it forward.
And when was the last time the contango was this steep? In 1998, when the price of crude fell to under $10. Historically, a contango this steep is consistent with a glut. And while oil prices did increase from the 1998 bottom, they had reached just under $12 by year end and $16.50 by year end 1999. That may sound like an impressive recovery, until you consider that oil had been nearly $29 at year end 1984, $23 at the close of 1990, and over $18 at year end 1997 (which was lower than 1996). That is a long-winded way of saying a sharp recovery from the bottom (which some are now saying could be as low as $25) does not appear likely.
An article in today’s Financial Times keys off the downbeat oil demand forecasts from the World Bank and the US Energy Department. First, from the FT piece on the two studies, “Global demand for oil to plummet“:
Global oil demand will collapse next year and commodities will not return to the highs they reached this summer in the foreseeable future, two authoritative reports said on Tuesday as they forecast a long and painful worldwide recession….
The US energy department said global oil demand will fall this year and next, marking the first two consecutive years’ decline in 30 years….
Meanwhile, the World Bank’s Global Economic Prospects report said the commodities boom of the past five years – which drove up prices 130 per cent – had “come to an end”.
The World Bank’s analysis of the commodities boom contrasts with the prevalent view among natural resources companies – and most Wall Street analysts – that the ongoing price drop is a correction within an upward trend….
Oil would return to about $75 a barrel within the next three years, it said, while food would trade 60 per cent higher than in 2003, but about half below this year’s record.
“Over the longer run, the price of extracted commodities should fall,” the bank said, adding that because of slower population and income growth, world demand for raw materials will ease.
Andrew Burns, the leading author of the report, dismissed the idea – widely supported among the industry and international bodies such as the International Energy Agency – that the credit crunch could result in higher prices when the economy recovers as companies cancel supply expansion projects.
The bank forecast that world trade – an engine of growth for many developing countries – would contract for the first time since 1982.
The World Bank report is significant because it tends to err on the optimistic side with growth forecasts.
The longer FT article, “So long, super-cycle,” looks at how our latest commodities cycle compares with past ones, and also focuses on the role of emerging markets. We’ve extracted (no pun intended) some of the juicy bits from this long but worthwhile article:
The common belief in the industry itself, and among most Wall Street analysts, is that the market is undergoing a correction but that the boom years have not ended….
But a growing minority disagrees with this rosy view. With its report released on Tuesday, the World Bank has put itself among the most vocal in warning that the commodities boom has come to an end. Some executives in the natural resources industry agree – in private….
Although most proponents of this argument see prices remaining well above the lows of the 1990s, they do not forecast a return to the torrid levels of this summer. That is because a more slowly expanding population and weaker rises in income will ease global economic growth – and commodities demand – in the next two decades.
Yves here. Demographic changes have not gotten the attention they merit. In addition, China also announced its intent to use the plunge in oil prices to reduce its energy subsidies further next year. China has come to realize that making fuel artificially cheap has made its manufacturers and products energy-inefficient, and it need to move pricing to world levels.
Back to the article:
They dismiss the notion that the credit crunch will trigger shortages in the future as companies cancel investment projects. Any increase in demand will first slowly have to absorb the current build-up in dormant capacity as companies cut their production….
For its part, the natural resources industry points out that falling supply in some areas and commodities – such as mature oilfields in the North Sea or old gold mines in South Africa – will support prices even if demand is weak. But pessimists say that the rapid fall in demand will leave the system with plenty of spare capacity.
Both sides have powerful arguments but history says that commodities booms last about a decade – almost exactly the length of time that oil prices were on the rise.
Whatever the disagreements, pessimists and optimists see eye to eye on the next 12-24 months: it looks grim for commodities….
“The main difference for commodities is that our view for emerging countries’ near-term economic growth is now more pessimistic,” says Thomas Helbling, an IMF economist who specialises in commodities issues. Relatively high-growth emerging countries consume more energy and other basic products than developed nations as they build infrastructure and embrace new forms of consumption, from cars and washing machines to meat and refrigerators….
According to the World Bank, Chinese economic growth will slow to 7.5 per cent in 2009, the lowest rate since 1990. But some bankers and mining executives are even more pessimistic, saying that activity in some sectors has already almost stopped…
But for investors, executives and bankers alike, the commodities boom and bust cycles teach that extrapolating today’s events into the future may prove the wrong bet. Ten years ago this week, when oil prices bottomed at $9.64 a barrel, the common wisdom was that commodities prices were heading down. Today’s forecasts could prove equally fallible.
PEAK PERIODS OF THE PAST: IN STRENGTH, LENGTH AND SCOPE, IT HAS BEEN THE BOOM OF A CENTURY
The last five years’ commodities price surge has been the most marked of the past century in its magnitude, duration and breadth – with the cost of energy, metals and food all swept upward…
The length of the 2003-08 boom has also surprised many. The jumps of the 1950s and 1970s were shorter, although the first world war brought a similarly long period of strength…
Yet the sheer size of the rises also stands out. “The magnitude of commodity price increases during the current boom is without precedent,” says the World Bank in its latest report.
It notes that prices in real terms – inflation adjusted – have increased by 109 per cent in US dollars since 2003 and 130 per cent since the cyclical low of 1999.
By contrast, increases in earlier booms never exceeded 60 per cent, according to the bank’s estimates.
From trough to peak in the oil market, prices rose – in nominal terms – by 1,415 per cent between December 1998 and last July.