Commodities still falling

Commodities have not been having a good day for quite some time. Commodities indices display this fact starkly.

Source: Bloomberg

Both the Continuous Commodity Index (CCI) and the CRB Commodity Index have fallen to six-year lows.

While various commodities have individual reasons explaining the tepid prices, the key factor was a mismatch in the textbook demand and supply curve. This gap between rising supply and slowing demand point towards two forces depressing commodity prices. The cyclical factor is the first force. The world economic growth has been stagnating for the last few years and commodity demand is primarily a function of GDP growth. Lower GDP growth means lower demand for natural resources. The second force is secular in nature. High commodity prices in the recent past led resource companies to make a beeline for capital investments. This created an over-supply issue, which was exacerbated when global demand started to drop.

There are also other factors working against commodities, including a stronger US dollar. Many key commodities are priced in the greenback, such as crude futures and gold. This means that when USD strengthened, it became less affordable to hold these assets. 

Copper futures tumbled to a six-year low at $2.3855 per pound. The metal had fallen 19% since the 2015 highs on 15 May, and is down 15.6% on the year. Goldman Sachs estimates that prices will  fall another 15% by end of the year, so we could see copper heading towards $2.00. Copper has historically been used as an indicator for raw materials as well as a gauge of global growth. Weakening copper prices naturally do not bode well for either.

As commodities continued to decline, investors are pulling out from commodity investments. The Wall Street Journal noted that investors pulled out $1.1 billion from commodity-sector funds in Q2 2015, citing data from EPFR Global. It did not help that equity and bond markets are more attractive as investments than raw materials. Generally, decreasing commodity prices would help equity and bond markets. The disinflationary effect would reduce the need for central banks to raise interest rates, which is positive for bond prices, given their negative correlation. Furthermore, lower input costs should improve the profitability of businesses, particularly manufacturers. Clearly, mining and resources companies would not be a good bet.

Asia set to start on a soft footing

US equities appeared to hit a snag, with earnings results coming in mixed after getting off to a good start last week. Caterpillar and several other companies reported disappointing earnings. S&P 500 closed down 0.6%, almost ending below 2,100 points. About one-third of companies have reported their profits, and so far, the sales and earnings growth have not been impressive. This would explain why S&P has not been making new highs. The fact that the market participation in the stock index has been falling suggests that upward momentum may be faltering.

Nonetheless, the weak performance in overnight US markets may give Asian investors cause to be cautious in today’s session. We have two instances of PMI data coming up. China’s private PMI number for July, the rebranded Caixin PMI, is expected to underscore the stability in the manufacturing sector. However, the consensus is still looking at a sub-50 reading at 49.7. A couple of economists are expecting an above 50 number. Japan is also releasing its preliminary PMI for July where the market is eyeing 50.5, an improvement from 50.1 in the prior month. Singapore’s industrial production will also provide some colour.

For Singapore, the Straits Times Index should encounter some support at the 3350 level, though we won’t rule out intraday slippages below that level, given soft leads from overnight markets. Investors would also monitor Noble, after the Group Chairman bought 15 million shares yesterday, raising his stake in the company to 21.8% from 21.6%. The counter fell 3.1% to close at SGD0.63 on Thursday, the lowest since Jan 2009. With a gloomy global commodity outlook, it may be difficult for the company to see much upside in its share prices. At best, we may see some stability in price action.

This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.

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