KINGSTON, NY, 5 August 2015—When is a “crash” called a crash?
The Bloomberg Commodity Index is at a 13-year low. Last month, the S&P GSCI total Return index, which tracks a basket of commodities, fell 14 percent. That was its worst decline since November 2008. Twenty-three of the 24 index components tracked, registered losses for July.
The word on Wall Street is that commodity prices are down on rising expectations that the Federal Reserve will boost interest rates by year’s end. Therefore, since commodities are traded in US dollars, it will become more expensive for other countries, whose currencies are declining, to buy raw materials.
We disagree. The greater issue is supply and demand. Europe’s growth, at best, is tepid. China, the world’s largest consumer of raw materials, is in an economic slump.On Monday, Caxin/Markit China Manufacturing Purchasing Managers’ Index (PMI) fell to 47.8 in July. A reading below 50 signals contraction. Profits of China’s industrial firms fell 0.3 percent in June year-to-date.
In the United States, the world’s largest economy, manufacturing cooled in July with the Institute for Supply Management’s index falling to 52.7 from 53.5 in June. And last week, The Bureau of Economic Analysis revised Gross Domestic Product growth for the past three years down to 2.0 percent from 2.3 percent and reported business spending had its worst performance since third quarter of 2012. As the Wall Street Journal noted, “data revisions going back more than three years shows the expansion – already the weakest since World II – was even worse than previously thought.”
Moreover, for an economy in which some two-thirds of GDP is consumer driven, with the Employment Cost Index increasing by only 0.2 percent in the second quarter – the smallest quarterly gain since record keeping began in 1982 – retail sales will suffer as real wages stagnate and/or decline.
As for plunging currencies, it’s all connected. As we wrote last week, “It’s a very simple formula: When the United States and Europe buy fewer consumer goods, China manufactures less of them. And the less China manufactures, the fewer raw materials and agriculture goods they import from resource rich nations. As exports decline from resource rich nations their economies grow weaker, their currencies fall lower… .”
And when the Fed does raise interest rates, those commodity-exporting nations already easing monetary policy in hopes of increasing exports, will see their currencies plunge deeper against the dollar.
Equity Markets Beware
The consequences of diving commodity prices extend beyond lost jobs and companies’ shares and profits being battered. For example, when the big US shale boom took off in 2009, both investment and debt load soared in oil related industries. According to Dealogic, energy companies accounted for 15 percent of all junk bonds sold since 2009.
Is there panic on the Street? The trend is your friend. According to data provider Markit, the number of investors shorting stocks in the S&P 500 hit its highest level since December 2012.