November 25, 2015
Commodity traders have been hurt by falling prices for months now, especially in the oil and metals markets. The Bloomberg Commodity Index, a good measure that tracks 22 commodity instruments, has fallen to its lowest level since 1999. Much of the fall has come from lower demand in China.
China, of course, is the world's second largest economy, and their usually booming export trade was a bright spot during rough economic times. However, Chinese trade, both imports and exports, were down heavily in October and several early reports, including manufacturing PMI and business sentiment, show further slowing for November.
The slowdown in China was the first blow to the commodities markets, but a second blow has come from the United States. Not from a slowing economy – indications are that the US economy has been growing a modest but positive rate of 2% annually – but from the central bank. The US Federal Reserve, charged with maintaining the stability of the US dollar, has been observing the recovering US economy and sending out indicators that it is ready to reverse its policy of low interest rates.
The Fed established that policy some eight years ago, as the last recession began, by lowering rates to create "easy money" and economic stimulus. The efficacy of the policy does not need to be discussed here; let's look at what is happening now, as the Fed gets ready to change course and raise rates from a mere 0.25%.
The immediate result has been a strengthening of the US dollar. This would almost certainly have happened anyway. Europe, Japan, and China are all facing economic slowdowns or recessions; among the major economies, only the US is experiencing real growth. This alone would have boosted the dollar. The prospect of higher interest rates, however, has given the dollar a true shot in the arm.
Higher rates mean a better return on investment, and that's the goal of any investment. Over the last six weeks, just the talk of higher rates has been enough to draw capital into dollar assets and away from commodities. In addition, as the dollar strengthens it makes commodities, which are usually priced in dollars, more expensive for foreign currency holders. Along with slowing demand, the result has been an accelerating decline in raw materials prices worldwide.
The market is complicated, however. Commodity production remains high, despite the low prices, because producers are paying their expenses in weaker local currencies but selling their product in stronger dollars; they are able to use the exchange rates to ensure a good profit. They don't yet have an incentive to cute production.
The world is awash in commodities. Oversupply, a strong dollar, and weak demand are all keeping prices down. Using oil as an example we find that supplies are at record levels, so high that oil tankers are taking longer routes and spending more time at sea to avoid having to unload. The Gulf of Mexico currently has 39 oil tankers waiting to enter the port of Galveston, Texas.
Tying this to current market movements, we find that even unrest in the Middle East can't derail the dollar's momentum. Yesterday, the dollar retreated slightly on the news that the Turks had shot down a Russian jet; today, the dollar is back up and more. The EUR/USD is trading for 1.0587, the GBP/USD is at 1.5063, and the USD/CHF is at 1.0212. For the Euro, this is an eight-month high; for the Swiss franc, it is the highest level since the Swiss de-pegged from the Euro back in January. The US dollar index is currently at 100.05.
In the commodity markets, we find energy and metals all sliding downwards today. Oil had a brief rally over the last couple of days, but WTI, the US price, is down one dollar at $42.26 per barrel. Brent, the global benchmark, is trading for $45.52. Gold is selling for $1,073.75, down two dollars from yesterday, and silver is down ten cents at $14.11.
Tomorrow is the Thanksgiving holiday in the States, so markets there will be closed. It will be interesting to see how prices shift when trading resumes in the States on Friday.