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Copper dipping below $6,000. West Texas Intermediate crude testing $68. Gold crashing through $1,220. Photo: Bloomberg
Copper dipping below $6,000. West Texas Intermediate crude testing $68. Gold crashing through $1,220. Photo: Bloomberg

Global market calm at risk as commodities sink into correction

Commodities have tumbled into correction territory, sliding again in the face of the resurgent dollar and lingering global trade tensions

London: Don’t be fooled by the relative calm across financial markets: The inputs in the global supply chain are flashing warning signs.

Commodities have tumbled into correction territory on Thursday, sliding again in the face of the resurgent dollar and lingering global trade tensions. Among the recent milestones: Copper dipping below $6,000. West Texas Intermediate crude testing $68. Gold crashing through $1,220.

The metal moves, in particular, are key to investors. Prices in the sector can be used to predict the pace of global growth before other measures, like business surveys or trade data, even become available. They would have presaged an upturn in early 2016, for instance, according to Bank of England economist Tom Wise. Most forecasters didn’t.

“Metals prices are timely, highly correlated with world economic activity and perform well at predicting short-term movements in GDP," Wise said in research published on the central bank’s blog. “Consumption moves very closely with GDP."

As the Bloomberg Commodity Index declines 10% from its almost three-year peak in May, here’s a look at how the sell-off is feeding into other assets.

Stock sickness

The moves are clearly showing up in equity markets, with miners the worst performers in the Stoxx Europe 600 Index this month.

That miners are heavily exposed to metal prices is predictable, but the dependence is growing. A 10% move in the LMEX Index of six base metals corresponded to a 7 percent move in the Stoxx Europe 600 Basic Resources sub-index in the past year — that’s stronger than during the preceding decade, according to data compiled by Bloomberg.

FX effects

The weakness in material prices is spilling over into the currencies of producer nations.

Almost all of the 22 raw materials comprising the Bloomberg Commodity Index have fallen since the May peak, with only live cattle, cotton and orange juice futures bucking the trend. Copper, often used as bellwether for the global economy due to its wide-ranging industrial applications, fell 18% in the period.

The same picture is on display in emerging-market currencies, where 21 out of 24 tracked by Bloomberg declined. The biggest losers included nations such as South Africa, a producer of base and precious metals and coal; Brazil, which exports iron ore, agricultural and petroleum products; Chile, a major copper producer; and Russia, which relies on natural gas, metals and other commodity exports.

“A looming trade war and uncertainty about Chinese demand weigh on commodity prices and related currencies," said Georgette Boele, currency and metals strategist at ABN Amro Bank NV. “As long as there’s nervousness about China, commodities will remain exposed to the trade war."

In a vicious circle, both the currencies of producer nations and commodities face not only the threat of a protectionist-driven slowdown, but also the strengthening dollar, which advanced for a third day on Thursday. The greenback is getting a lift from the trade dispute, as American growth remains robust and investors switch into US assets.

Emerging pain

The recipe for other developing-nation assets is toxic. The correlation between the Bloomberg Commodity Index and the MSCI Emerging Markets Index of stocks has strengthened — in April it hit the highest level in more than five years when measured over 120 days.

Of course, weakness in raw materials may be a knee-jerk change in sentiment that has little to do with fundamentals. Analysts at ING Bank NV and Commerzbank AG both see the sell-off nearing its bottom with prices expected to recover in the final quarter of the year when the hostilities of the trade war ease.

“Prices have come down too far and we expect a sharp counter-movement once the situation calms down," Daniel Briesemann, analyst at Commerzbank, said by phone. “Many speculators have already withdrawn their positions so the headwinds base metals have faced should start to abate. Further out the fundamentals in most cases show tight markets."

Meanwhile, the pass-through of commodity prices to other markets is not straightforward because raw materials have a dual role as an input cost as well as a barometer of demand. When prices fall it can feed into the real economy, working against inflation and potentially resulting in easier monetary policy — which could ultimately help spur financial assets.

Demand doom loop

Yet the lower prices of raw materials have immediate implications for investment spending, and may impact consumer sentiment. For example, as much as 10% of copper production is now unprofitable, according to research from BMO Capital Markets. That could eventually mean layoffs or lower capital investment, which loops back into global demand.

“The potential damage to the global economy extends beyond trade," Jon Harrison at TS Lombard said in an emailed note. “Uncertainty may already be discouraging investment and emerging-market assets will react to US threats of further escalation even if the threatened actions are not ultimately implemented."

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