Everyone knows the broader story for commodity prices in 2008;
it was a tale of two wildly differing six-month periods. For the
first half of the year virtually every commodity soared in value;
after July 4, there was a collective nosedive. The
Reuters/Jefferies CRB Index (CRB) ended the year with a loss of
around 36 percent, despite the more than five percent gain on the
last day of the year.
During the first half of 2008 everything seemed to favor higher
commodity prices. Investors who were jittery about the subprime
situation, the collapse of Bear Stearns and the weakening dollar
flocked to gold and other commodities. Analysts focused on supply
bottlenecks in agricultural and industrial commodities and touted
growing demand from China, India and others. With risk appetite
alive and well, the speculative bubble flourished, aided by Goldman
Sach's forecast of $200/barrel oil prices.
Everything changed after July 4. As our economy slowed and
consumers felt the pinch, consumers drove and consumed less and
criticism of oil companies grew. Congress threatened legislation to
clamp down on speculation. As the financial crisis widened and
signs of a global slowdown grew more widespread, the downward
spiral in prices gathered momentum. Hedge funds that had been a
large part of the run-up were forced to liquidate positions and
this added fuel to the sell-off.
There are six groups of commodities within the index (
click here to see the full list and returns).
Out of the nineteen commodities within those groups, only four eked
out gains in 2008. While the losses were widespread, the energy and
industrial commodities were especially hard hit for obvious
reasons.
So what does the future hold? The energy complex is perhaps the
most difficult to predict. Clearly, global demand has slowed, but
so has supply as OPEC has announced production cuts. It appears as
if Saudi Arabia and the UAE, two large producers that have
historically been reluctant to cut production, will abide by the
cuts. For now, it appears as if there has been a shift in sentiment
towards greater conservation in the U.S. and the rest of the
developed world. However, it is harder to predict the actions of
China, India and others, once growth picks up again. Overall, my
sense is that we may have seen the bottom in December around
$33/barrel, but the range for this year will probably be a narrower
one, perhaps capped around $75/barrel. How long we remain in that
range depends on several factors, but mainly on the trajectory of a
global economic recovery.
Industrial commodities are likely to stagnate somewhat longer, in
my opinion. Supplies are ample, demand destruction has been fairly
dramatic and it will take time to work off the imbalance. I do not
expect a recovery until 2010 and there is a chance prices could
head significantly lower in the interim. I am more positive on two
major groupings: grains and metals. Demand for grains tends to be
more stable and now that the speculative element is largely absent,
we could find a bottom sooner in that space. I am constructive on
gold and silver as I expect the dollar to remain fairly weak for
most of 2009, which will underpin prices this year while in 2010
and beyond growing inflationary fears should boost prices. I have
no particular opinion on soft commodities and livestock.
Overall, I expect a less volatile year for commodities, as much of
the speculative element has disappeared, leaving cash and hedging
transactions by producers and buyers as the main drivers. I suspect
the CRB index will probably rebound from its 2008 losses, but not
by a meaningful amount as sectors within the index will perform
differently. Barring another significant setback for the global
economy, the currencies of commodity producing countries should
similarly be less volatile and I would expect most of the stronger
ones (AUD, BRL and others) to form a bottom this year and build on
those gains in 2010.
Looking Ahead
My core view remains unchanged; the dollar could head lower in Q1
and it is doubtful whether it will mount any sort of recovery later
this year. I expect a weak economy and aggressive quantitative
easing by the Federal Reserve to pressure the currency.
Last week and on Monday, the GBP bounced vs. the EUR ahead of
hitting parity (it got to .98 GBP per EUR) and this boosted the GBP
and pressured the EUR. Despite that, another test of 1.00 is
possible; were it to take place, there is a chance of another test
of the 1.47 to 1.50 area for the EUR vs. the USD. As I said last
week, those levels should contain any EUR rally for now, as it has
perhaps risen too far and too fast, given the weakness in the
European economy and the likelihood of further rate cuts. The GBP
is not out of the woods despite the short-covering rally and could
test 1.40 soon, before strengthening later this year.
The JPY lost some ground as equities rallied, but should remain
fairly strong in the near term - perhaps in a 90 to 95 range -
while risk appetite remains low. Later this year, if the global
economy recovers, risk appetite improves and yields rise, the JPY
will gradually lose its allure.
U.S. asset markets are likely to bounce in Q1 on hopes that a new
administration will address and perhaps resolve the economic
crisis. I think economic weakness is too widespread and entrenched
to respond to any quick fix. As a result, I believe that bounce
will be followed by disappointment and another sell-off that should
extend through Q2 and Q3, followed by perhaps another (more
well-founded) rally at the end of 2009 or early 2010. As a result,
I would personally fade dollar, equity or commodity strength in the
next few months and continue to buy fixed income assets on
dips.