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Do Falling Commodity Prices Spell Trouble?

Do Falling Commodity Prices Spell Trouble?
By Ron DeLegge, Editor
June 2, 2010

SAN DIEGO (ETFguide.com) – Wall Street’s ever rosy forecasts for accelerating economic growth aren’t coming true. And neither are its predictions of higher commodity prices.


In fact, the price of major commodities like oil, sugar, and steel have been sliding. The iShares S&P GSCI Commodity Index Trust (NYSEArca: GSG), which tracks a basket of 24 different commodities, is down 14.55 percent year-to-date. Other commodity ETFs like the PowerShares DB Commodity Index Trust (NYSEArca: DBC) are following suit.

Stocks in the basic materials sector (NYSEArca: XLB), steel (NYSEArca: SLX) and hard assets segment (NYSEArca: HAP) have fallen between 9 to 14.50 percent too.

Do falling commodity prices spell trouble ahead?

Supply and No Demand
The U.S. rate of inflation is near 44-year lows. From April 2009 to April 2010, consumer prices rose just 0.9 percent and commodity prices are following that lackluster lead. As a result, stocks in countries that previously benefited from high commodity prices in places like Brazil (NYSEArca: EWZ), China (NYSEArca: FXI) and Russia (NYSEArca: RSX) are all underperforming.

Elsewhere, global manufacturing slowed in China, Europe and the U.S. during May. The declining price for industrial metals illustrates this. Over the past month alone, nickel (NYSEArca: JJN) fell almost 25 percent. If greater demand for commodities due to economic growth exists, financial markets sure don’t reflect it. 

Nevertheless, lower commodity prices have done little to dissuade the Organization for Economic Cooperation and Development (OECD) and other economic constituencies like it from revising their fairyland growth forecasts. According to the OECD, global economic expansion will increase by 2.7 percent this year. Commodities markets have seemingly already beaten the OECD into realizing that its growth forecasts are off.

Inflation is good…sort of
Inflationary prices reflected in higher commodity prices are generally good, so long as it doesn’t get out of control. The Federal Reserve also knows that if inflation doesn’t rise adequately enough, it could leave them without a valuable tool should the U.S. economy head into a double-dip scenario; the power to ease interest rates. (Right now, this option is off the table since rates are already near zero percent.)

Usually the summer traveling season means higher gasoline prices, but not so far. Here too, inflation is non-existent. Right now the national average for gasoline prices is around $2.72 compared to $2.92 almost one month early.

Early on there was speculation the Gulf of Mexico oil spill disaster would translate into soaring oil prices, but it’s had little impact. “The BP well had just been drilled and had not been put on production, yet. The incident did not take any current production off the market,” states Alex Mills is president of the Texas Alliance of Energy Producers. According to the Energy Information Administration, the gulf’s offshore industry represents around 30 percent of the total crude oil production in the U.S.  

Pressing the Rewind Button
Interestingly, commodities are in their largest slump since the storm of the 2008 Credit Crisis. Upon closer observation, the fall in commodity prices back then signaled big problems ahead. Wasn’t it months later when stocks would hit lows not seen since the mid-1990s? Along similar lines, does today’s fall in commodity prices signal turbulence just ahead? Is this our warning sign?

This time around history may not necessarily be repeating itself verbatim, but perhaps a similar rhyme of the recent past is possible. Only time will tell.  

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