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Are Commodities Down for the Count?

Posted on: August 16, 2008 - Email Article - Printable Version

Darrell Reid

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August has been a horrible month- or has it? I guess it depends on how you look at it. Commodities have been hammered in recent weeks as disappointing economic data indicates a global slowdown and rising inflation that is finally starting to make feverish consumers reconsider their expenditures. The dollar’s rally has caused the commodities sell-off. The dollar’s price action has forced many international participants out of commodities and shareholders are unloading anything related to the asset class. Some are even quick to sight the past eight-week performance as the end of the bull run for commodities. Why is it that weak economic data is good for the dollar, but bad for commodities?

Recent Economic Data

Q2 GDP: 1.9%
Domestic Factory Orders: 1.7% M/M
ISM Non-Mfg Index: 49.5
International Trade: -$56.8 Billion
Industrial Production: 0.2%
Empire State Manufacturing Index: 2.8

The service sector is in a state of contraction which has taken its affect on GDP which missed consensus. Factory orders were up month to month indicating companies are active in trying to expand operations, a good notion for the dollar. The trade deficit beat expectations of -$61.8 Billion, a good sign considering many have looked international trade to pick up the slack in times of a weaker dollar and slowing economy. Industrial production and the Empire Mfg Index both beat expectations. Commodities will suffer further as the dollar strengthens, but shouldn’t increased construction be a good sign for commodities?

Consumer Data

Domestic Consumer Spending: 0.6% M/M
Domestic Retail Sales: -0.1% M/M
CPI: 0.8%

Consumer strength is waning as price increases pressure demand. To complement the slowing American economy, the IMF cut growth expectations for the U.K from 1.8% in 2008 and 1.7% in 2009 to 1.4% and 1.1% respectively. U.K. CPI rose by a staggering 4.4%. It is here that commodities prices is most apparent and it is logical that high prices would deter consumers. Recently there was an article in the Wall Street Journal sighting disappointing production from 15 member nations within the Euro Zone. Spain’s production fell 9% and inflation increased 5.3%. With numbers like these it would make sense that demand would slow and commodities prices fall, but why is the dollar moving in the opposite direction?

Has the dollar always moved in the exact inverse of commodities? The short answer is yes. But what is unique this time around is the severity of adjustment on the commodities side. Commodities have nose-dived this past month. Weak economic data definitely shows a slowdown in consumption and demand for commodities themselves. However, a lot of the new economic data is coming from other nations strengthening the dollar on a relative basis making commodities more expensive abroad.

The U.S economy isn’t getting better- other nations are doing worse.

This double whammy effect is why commodities are down roughly 20% from the beginning of June. With that said I do believe the worldwide economy is in for a slowdown, but by no means do I believe the commodities trend is over. Not when China and India have economies whose consumers only consist of about 30% of total GDP. Developed nation’s consumer spending account for at least 2/3 of total GDP and nearly 70% in the U.S. Emerging economies have a long way to go and in the long term commodities prices will be supported. The short term correction we are seeing is by no means the final “hoo-rah” of commodities.

- Darrell Reid

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