Tuesday, July 28, 2015

What Are Commodities Telling Us About the World's Economy?

In the mainstream media, we keep hearing about the strength of the United States economy.  Growth is reasonable, headline unemployment rates have reached relatively healthy levels and the dollar is strong.  That said, the world's commodities are having a terrible year.

Let's open by looking at what makes up the Commodity Research Bureau Index or CRB.  The CRB was founded in 1957 and follows the index of commodity futures.  Over the decades, it has been revised several times to reflect commodity market evolution.  It currently consists of 19 commodities with the CoreCommodity CRB Index having the following weightings:

The most recent revision was in 2005; this revision changed from an equal weighting for all components to a four tired group system that was designed to reflect the significance of each commodity as follows:

Precious Metals: 7 percent
Base and Industrial Metals: 13 percent
Energy: 39 percent
Agriculture 41 percent

Here is a chart showing what has happened to the Reuters/Jefferies Commodity Research Bureau (CRB) Index since February 2008:

The CRB Index high point over the last eight years (since just prior to the Great Recession) was 473.9669 in July 2008 and the low point was 200.1563 in February 2009.  The current index at 205.04 is well below the 8 year average of 296.98 and at its lowest level in more than six years.  As well, the CRB has dropped by 44.65 percent from its post-Great Recession high of 370.47 at the end of March 2011.

Here's what has happened to the CRB over the past year:

At the end of July 2014, the CRB was at roughly 298.  On a year-over-year basis, the CRB Index has fallen by 31.2 percent and has dropped by 10.1 percent since the first trading day of 2015.  Obviously, with the weighting given to oil, at least some of this commodity collapse is due to the falling price of oil but there is more to the story than just oil.

I find it particularly fascinating that, even with the world's central banks increasing the world's monetary base through quantitative easing and other imaginative monetary programs, all of that cash seems to have left the commodities markets, seemingly with a preference for both stocks and bonds which have left stock markets overvalued and bond markets extremely fragile, particularly when interest rates rise.

Let's take a look at one key commodity that, while it gets less attention than oil, is often considered to be a bellwether for the world's economy, thus, the nickname "Doctor Copper".  Here is a chart showing what has happened to the price of copper since mid-2005:

Over the past eight years, copper has ranged in price from a high of $4.625 on July 11, 2007 to a low of $1.250 per pound on December 23, 2008 with an average of $3.375 per pound over the entire period.  After the so-called end of the Great Recession, copper hit a high of $4.623 per pound on February 14, 2011.  Copper traded above $3.00 per pound until mid-March 2014 and then began to show greater signs of weakness in December 2014 when it consistently traded below $3.00 per pound.  

Here's what has happened to the price of copper over the past year:

At its current level of $2.38 per pound, copper is down $0.87 per pound or 26.9 percent on a year-over-year basis and is down 48.5 percent from its post-Great Recession peak in February 2011.  "Doctor Copper" is certainly suggesting that the world's economy is heading for a slowdown.

For those of us that watch commodities on a regular basis, the recent very significant decline in the price of many of the globe's key commodities suggests that the world's economy is teetering on the edge of an economic contraction, particularly given that many of the commodities in the CRB index are building blocks of a healthy and growing economy.  Certainly, some of the drop in prices for commodities can be laid at the feet of a strong U.S. dollar which has made it substantially more expensive for holders of other currencies to buy these same commodities, an issue that has put at least some downward pressure on demand.  However, even if things are looking rosy for the United States economy, the flagging economies of both China and the European Continent would suggest that all is not well in this globalized world, just as the world's most powerful central bank is considering a dovish monetary policy stance.

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