Commodities Advance to One-Month High On Stimulus Speculation
Comment of the Day

July 03 2012

Commentary by David Fuller

Commodities Advance to One-Month High On Stimulus Speculation

Here is the opening for this short item from Bloomberg today:
Commodities advanced to the highest level in more than a month on expectations that central banks in the U.S., Europe and China will ease monetary policy to spur growth, boosting demand for raw materials.

The Standard & Poor's GSCI Spot Index gained as much as 2.2 percent to 610.58, the highest intraday level since May 30, and was at 610.48 as of 1:50 p.m. in London. Crude oil gained as much as 2.8 percent, copper rallied to the most since May 22 and gold traded at the highest in almost two weeks.

The European Central Bank is forecast by economists to cut interest rates this week to help curb the debt crisis while a state-owned newspaper in China said the time is ripe for a reduction in the reserve requirement ratio for major banks. Declining employment figures this week may prompt the Federal Reserve to initiate fresh stimulus, BNP Paribas SA said.

"The mood on the financial markets has generally been bright since the end of last week,"Andrey Kryuchenkov, an analyst at VTB Group in London, said today in an e-mailed note. "Gold is reaping the benefit of market expectations for further monetary easing around the globe to stimulate economic growth."

David Fuller's view For over a decade, when the consensus view has proclaimed that the commodity supercycle either never existed or is over, contrarian thinkers among us should start looking for evidence of the next significant low.


My own view for a number of years is that a commodity supercycle was occurring partly in response to the historically low prices for many natural resources for two decades prior to this century. This left producers of most industrial commodities and some foods ill-prepared to increase production when demand eventually increased.

It certainly did increase early on in the last decade, due mainly to globalisation, the adoption of capitalism in various forms by previously moribund economies, and the emergence of a new middleclass in China-led growth economies which also had large and increasing populations. This created a commodity supercycle which has arguably been greater in real terms than the 1970s surge in prices for all industrial and agricultural commodities, and not least precious metals.

You can see both the earlier supercycle and the current one on this monthly semi-log chart of the unweighted Continuous Commodity Index (CCI) (Old CRB). Many people felt the supercycle, if it even existed, was buried by the 2008 crash. However, all classes of commodities recovered very quickly in 2009, taking CCI to a new all-time high.

Commodity moves are cyclical so they will inevitably respond to global economic conditions. However, they also play a significant role in creating GDP growth spurts and also slowdowns. For instance, low commodity prices reduce inflationary pressures, enabling central banks to provide more liquidity for GDP growth. In contrast, high commodity prices, especially for crude oil, create inflation which central banks attempt to curb with tighter monetary policies, as we saw in 2008 and also in 2011 in growth economies, continuing into this year when oil prices surged again.

Recently, we have seen growth economies switch to more accommodative monetary policies, following the commodity price reset at lower levels which you can see on this 5-year chart of CCI. Central banks felt they could provide a monetary stimulus, needed to counter the synchronised global economic slowdown, because lower commodity prices were reducing inflationary pressures.

However, we are seeing once again how quickly commodity prices can recover when a stimulus is anticipated. Some of this is short covering and CCI appears certain to at least complete a mean reversion to the declining 200-day MA. On reaching the MA it would still be in a medium-term downtrend but there are reasons for thinking that it will move somewhat higher over the next few months.

One of these is turbulent weather in some of the major growing regions for agricultural commodities, and not for the first time. This is becoming an annual trend, providing evidence of climate change, whatever its reasons. Of greatest concern recently, very hot, dry weather in Midwestern USA has certainly caused crop damage as I have been mentioning in Audios.

You can see the dramatic nature of these price increases in these 5-year weekly charts for corn, soybeans and wheat over the last three weeks. In a weather induced move of this nature it is very difficult to know where it will stop - hopefully soon - until we see these spikes lose upside momentum. At minimum that requires a break in the Midwestern heatwave.

Meanwhile, the implications are that the global economy will have little chance of rebuilding excess stockpiles of grains this year for the purpose of providing supplies when shortages occur. We may see more food riots in some developing countries. Fortunately, although some rough rice is grown in the US, the main crop is affected much more by weather patterns in other parts of the world, namely China, India and other Asia-Pacific regions, so it has not surged in price like the Midwestern US crops shown above.


This commodity review continues tomorrow.

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