Commodities Fad Could Soon Fade
This article is from the archive of The New York Sun before the launch of its new website in 2022. The Sun has neither altered nor updated such articles but will seek to correct any errors, mis-categorizations or other problems introduced during transfer.
It never fails. Like death and taxes, booms come and go. The horse and buggy, Hula-Hoops, the Internet rage of the late 1990s, and the country’s love affair with George W. Bush after September 11, 2001 are some conspicuous examples.
Morgan Stanley’s chief economist, Stephen Roach, thinks another boom may be running out of steam as well. He speaks of the three-year boom in commodities during which eager investors snapped them up like crazy. In the process they fattened their holdings in various investment vehicles with commodity trading advisers to the tune of more than $70 billion.
Such investments have essentially tripled in size during the past three years, while shooting up at about a 40% annual rate. What’s more, the $70 billion is most likely only a small portion of the whole commodity asset class.
In the past several weeks, though, the commodities boom — for the second time in the past five months — has been flashing signals it may be ready to turn into a commodities bust. In this period, commodities markets have been battered by intense selling pressure.
The numbers tell a bleak tale, with declines ranging from 8% in the Commodity Research Bureau’s futures index to 9% and 14%, respectively, for the S&P and Goldman Sachs indices. Meanwhile, spot oil prices have tumbled 17% from their highs of two months ago, while there have also been sharp declines in copper (off 7%), aluminum (9%), zinc (10%) and nickel (12%).
At the same time, gold, which a couple of months ago had topped $700 an ounce, has also taken its lumps. It closed Friday around $579, and there is some speculation if oil (currently $63.33 a barrel) should continue to slide — say to the low to mid-$50s over the next two months, as some Wall Streeters suspect — gold could easily drop to the $450- to $500-range.
In a commentary fired off Friday to Morgan Stanley’s clients, Mr. Roach notes that while recent declines barely make a dent in the major run-up in commodities prices of the past three years, cyclical turns have to start somewhere. As he sees it, the recent sell-off in commodities markets may well be a hint of more serous action to come.
The bear case for commodities, Mr. Roach figures, has three legs to its stool — the Chinese connection, the American housing market, and the asset allocation play.
Examining each, he kicks off with the most important one — the China factor, notably the country’s frantic demand for commodities. In the 2002 to 2005 period, for example, China’s share of the total growth in global consumption of industrial materials was off the charts: 48% in aluminum, 51% in copper, 110% in lead, 87% in nickel, 54% in steel, 86% in tin, 113% in zinc, and 30% in crude oil.
As long as China’s growth dynamic remains intact, its demand for commodities would appear to remain insatiable. But that is what is now changing, Mr. Roach points out. The Chinese government has sounded the overheating alarm and has taken action to slow its white-hot economy by tightening its monetary policy and issuing edicts aimed at slowing down investment projects in a number of hot sectors, such as aluminum, cement, steel, coal, glass and other building materials, autos, and residential property.
Mr. Roach notes that August data just released out of China points to the first signs of the long-awaited cooling off, namely meaningful deterioration in the growth rates of both industrial output and fixed investment — signs, he adds, that could well be indicative of a legitimate turn to the downside. If that is the case and Chinese industrial output growth decelerates further, he notes, then it is almost a mathematical certainty this slowdown would produce a major downturn in global commodity demand.
Looking at our housing market, the second leg of the stool, Mr. Roach says a post-housing bubble shakeout is a distinct negative for American commodity demand because it would impact the consumer’s wealth effect, and weaken commodity-intensive construction activity. It’s estimated, for example, 46% of total copper usage is earmarked for building construction, with about two-thirds of it used for residential homebuilding.
The final piece of the puzzle, the asset allocation play, relates to the recent multiyear upturn in oil and materials prices and the huge bucks poured into commodities, which, in turn, have legitimized them as a serious asset class for institutional and even some retail investors. A danger here, according to Mr. Roach, is just as return-hungry investors have chased commodities markets on the upside, they could run like lemmings to get out on the downside.
Our commodities worrywart is not predicting a crash in commodities, but he warns as China slows and the American property bubble bursts, a broad and protracted downturn can be expected in most economically sensitive commodity markets, including oil.
While predicting a downturn in commodities demand, Mr. Roach says,”I will definitely be wrong if the China slowdown doesn’t materialize.” Further, he says his call could also be problematic if the American consumer doesn’t flinch.