The great bear market

By Buttonwood

HAD stockmarkets fallen more than 40% from their peak, the national news bulletins and the mainstream papers would be full of headlines about collapse and calamity. As it is, the FT did make commodities the splash today (plus a short view, plus a Lex) but there is less coverage elsewhere.

But this is one of the great bear markets. It may seem less important because few people are directly invested in commodities. But in terms of people's daily lives, commodity prices are very important indeed. The Arab spring started as a response to soaring food prices in North Africa. Rising and falling prices act as a tax rise/cut for western consumers. For commodity producing nations, falling prices mean loss export earnings, lost jobs and currency crises.

The key question of the moment is whether the fall in commodity prices falls into the good news (tax cut) or bad news (weakening global economy) category. Inevitably, the debate focuses around China, given that it was soaring Chinese demand for raw materials that was perceived to drive the great bull market last decade. We wrote recently about the way that the Chinese market was changing, as the country has less need for more infrastructure, and thus for iron ore, steel, copper etc. The Chinese have also been moving to a model in which they create more manufactured goods from scratch, rather than assemble parts made elsewhere; this may explain why other Asian exports have been so weak.

One can simply see the commodity price decline as the global economy doing its job, in the form of a super-cycle. Rising prices bring forward new sources of supply as production at marginal sites becomes profitable; they also cause consumers to economise on raw material use. This brings prices down, so production falls sharply, allowing the whole cycle to begin again. Beause it takes a lot of time to build new mines, develop oil fields etc, this whole process takes more than a decade.

Nevertheless, there seem to be broader signs of concern about the global economy which the commodity price decline seems to reinforce. Composite purchasing managers' indices for the manufacturing sector in the emerging market countries have dipped slightly below 50, indicating a decline in output. Figures show that unemployment in emerging markets has risen from 5.2% to 5.7% since the start of the year. The IMF cut its global growth forecast for this year to 3.3% from 3.5%, largely on American first half weakness. Hopes that the oil price fall in late 2014 would act as a big surge to western demand have only been partly fulfilled; auto sales may be running at the best rate in a decade but retail sales were up only 1.4% year-on-year in June.

Dating back to 2009, this is already a longish economic recovery and one that owes much to unprecedented monetary stimulus. It remains to be seen whether the Fed and the Bank of England, having stopped further QE, will be able to push on with actual rate increases, given the doubts about the global economy's robustness.

One regrettable element of this story is that too much focus is placed on the price of gold, one of the least important commodities in industrial terms. My colleague explains elsewhere why gold has been selling off. Any financial journalist who has written about gold will know that rational explanations about real interest rates, or the supply/demand balance, will not satisfy the gold bugs. Gold must rise, because central banks are debasing the currency and if it fails to rise that is because central banks are conspiring to hold it down. This is because they are trying to disguise the inflation that is really happening, hide the fact that they've long since sold their gold off, or whatever. While it is fair to say that central banks could generate inflation if they really, really tried (and thus owning a bit of gold might be a hedge against that possibility), they have singularly failed to do so. Indeed, the fall in commodity prices is pretty clear evidence of their failure. Unless you believe all those markets are rigged too.