Investors are fleeing commodities amid mounting worries about the slowdown in global growth and the significant price declines in commodities.
The World Bank, in its latest Commodity Markets Outlook, predicts that commodity prices will decline even further because of current excess capacity and easing demand from China.
The bank expects agricultural prices to decline some 11 percent from 2014 levels because of “abundant supply and high levels of stocks.”
How low are commodity prices?
On Friday, copper and silver sank to six-year lows. Gold declined to a five-year low. Oil prices pushed further below $50 a barrel. But that’s not all.
“The largest decline is expected for iron ore due to new low-cost mining capacity coming online this year and next, primarily in Australia,” according to the World Bank report.
The S&P GSCI, an index tracking a broad basket of commodities, fell to 3866, its lowest point in 2015.
Gold has dropped 8.3 percent so far in 2015. Gold’s outlook has changed starkly since the 2008 Great Recession. During that period, gold was viewed as a hedge against economic turbulence. Now investors have sold gold as concerns about a global economic collapse have receded and in anticipation of higher interest rates.
Now the supply of raw materials exceeds demand. The world’s two largest economies, China and the U.S., have growth challenges. China is the world’s largest consumer of industrial metals, while the U.S. leads global crude-oil demand. Recent data suggests that China’s factory activity has fallen to a 15-month low. The U.S. housing market appears soft and internal economic forecasts by the Fed show our economy is slowing.
The economic slowdown is a global phenomenon and not confined to China and the U.S. Global growth has averaged 3.3 percent in the years since the financial crisis, compared with 4.7 percent in the six years before 2008, according to the International Monetary Fund.
On Friday, Anglo American, one of the world’s largest mining companies, announced a layoff of 53,000 people over the next few years because of broad-based negative results. This would be some 35 percent of its work force. Anglo American is a major producer of platinum, diamonds, copper, nickel, iron ore and coal. The miner saw a 41 percent decline in iron-ore prices, a 19 percent drop in platinum, an 18 percent slide in copper and a 15 percent fall in coking coal in the first half of the year.
Even diamond revenues declined 21 percent.
Glencore Chief Executive Ivan Glasenberg rationalized that a lot of the decline in commodity prices derives from overproduction. Companies launched major additions to meet expected Chinese demand. Until demand improves, the prices for commodities will remain weak.
That lower prices are a bad thing is counter-intuitive. All of us enjoy getting bargains. Black Friday rounds out our Thanksgiving celebrations. But other than pleasing individual consumers, the steep price declines in commodities are worrisome because they increase the likelihood of deflation.
In a 2010 column in the New York Times, economist and Nobel laureate Paul Krugman discussed “Why is deflation, bad?” His answers:
1. When people expect falling prices, they become less willing to spend. Deflation becomes ingrained in the culture. Because people expect deflation, they will postpone buying, keeping the economy depressed. We then fall into a deflationary trap such as America experienced in the 1930s.
2. Falling prices hurt debtors because it increases the real burden of their debts.
The legendary economist Irving Fisher pointed out that debtors are likely to cut their spending when their debt burden rises. Creditors do not offset this. That is, creditors are not likely to increase their spending by the same amount as the decline from debtors. Decline in demand ultimately leads to the layoffs such as those experienced in our oil patch and by Anglo American.
And layoffs hurt consumers’ buying power, reducing the demand for commodities.
You can see where that spiral is headed.
Originally published in the Sarasota Herald-Tribune
