The first of two articles considers demand for commodities during the 10 years leading up to 2016.
In 2016, commodity prices fell back to levels last seen more than a decade earlier. During the preceding 10 years, there was a commodity super-cycle during which prices hit record peaks. The financial crisis and falling demand from China put paid to those records.
From 1999 through 2008, the overall pricing of commodities rose rapidly, driven by demand from burgeoning industrial and manufacturing output in China. The financial crisis choked demand for everything, including Chinese products. That sent commodity prices tumbling before continued economic growth in China, including a vast investment programme in infrastructure, pushed prices back up to a second, albeit lower, peak in 2011.
Chinese policymakers then began to curtail excessive lending within their own borders, and the redundant infrastructure that this was helping to support. As a result, the demand for and price of building materials and manufacturing metals receded. It’s worth noting that China remains by far the world’s biggest consumer of raw materials, accounting for around 50% of the global consumption of the likes of cement, iron ore, aluminium, nickel, coal, copper, steel and even pork.
Oil has significance that goes beyond the commodities markets. It has a major influence on inflation and industrial expenditure. As new sources of oil are being tapped (see below), the traditional power of the Organisation of the Petroleum Exporting Countries (OPEC) has been undermined, as has its constituent economies.
Nonetheless, oil prices followed a similar pattern to those of the broader range of commodities. Demand for resources had been increasing, leading to oil companies joining miners in investing heavily in production. This led to major new producers, especially those of shale-oil production in the US, increasing global supplies. (Oil trapped in shale rock deep underground is extracted by pumping a mixture of sand, water and chemicals into the rock. This creates fractures in the rock, leading to the term “fracking”, releasing the oil and pushing it into wells from which it can be extracted).
With oil supplies rising while demand failed to keep pace, stockpiles of oil rose sending the price of a barrel of oil back down.
By 2016, it was as if this commodities super-cycle had never happened. The Bloomberg Commodities Index fell substantially from the 2008 peak, to below its 1999 low. Meanwhile, oil peaked at around $140 a barrel before tumbling back down to below $30.
Since 2016, a great deal of the excess production capacity has been reduced. This has been due to a crack-down on unapproved metal production in China and oil prices falling below levels that cover production costs.
This has enabled the huge stockpiles of metals and building materials to be reduced significantly. What’s more, investment in the sector ground to a halt as companies tried to cope with the lower prices and the consequent effect on profits.
We also monitor the progress of and outlook for other commodities such as agricultural products and precious metals. Agricultural products are notoriously difficult to predict as they are at the behest of varying demand and the lottery of changing weather conditions. For example, 10 years ago the price of a soya bean future (what it would cost to lock in the price for which you could buy or sell soya beans) was around $10.00 per bushel (8 gallons). It then followed a downward trend to around $8.65 in early 2015. After that it climbed to a high of over $10.55 in May of this year before plummeting back down to $8.70 in July (the time of writing). All the time that these sharp changes in trend were taking place, the short-term price was even more volatile, making for a very difficult product in which to invest.
Another form of commodity often recommended for inclusion in mixed investment portfolios is that of precious metals. Many a newspaper column will recommend including a base level of, say, 5% to 15% of all investments be placed in gold. From 2008 through 2011, this would have paid handsomely as the price of gold rose from below $800 an ounce to more than $1,800. However, the value fell to around $1,200 in 2013 and has been trading between around $1,100 and $1,350 since.
Trying to judge when market prices are going to rise or fall is an extremely difficult task, and one in which we do not dabble, focusing instead on the longer term horizon. What’s more, gold pays no dividends or interest, so with inflation on the rise, its true value is being undermined.
Forecasts of future performance are not a reliable guide to actual results in the future, neither is past performance a reliable guide to future performance. The value of investments, and the income from them, may fall as well as rise and cannot be guaranteed. Any views expressed are our in-house views at August 2018. Investment markets and conditions can change rapidly and the views expressed should not be taken as statements of fact nor relied upon when making investment decisions. This information may not be used, copied, quoted, circulated or otherwise disclosed (in whole or in part) without our prior written consent.
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