3 Factors Keeping Commodity Prices Low

It’s been a dire summer for commodities. In July the price of all 24 quoted commodities fell. Such highly correlated price movements are a rare event. Since 1970, the only other time the prices of every commodity collapsed in unison was during the global financial crisis in October 2008.

However, July’s price collapse reflects a broader trend – commodities have performed badly for the last two years. The Bloomberg Commodity index has fallen by 34 percent since January 2013 while S&P GSCI index fell by 43 percent during the same timeframe.

But for the brave investor, the nadir in July might be exactly the right time to allocate to this asset class. One of the simplest and most successful investment strategies is to buy low and sell high.

China Is Slowing

To decide whether the current situation presents a good opportunity to buy into commodities, investors should take a closer look at what factors will drive the recovery of these global staples.

There have been three key macroeconomic factors driving the slowdown. Kevin O’Nolan, portfolio manager at Fidelity Solutions, said: “Over the past few years, China’s economic growth has slowed markedly.”

The world’s second largest economy is the largest consumer of a number of goods, including energy and industrial metals, so this slowdown had a direct impact on commodity prices.

U.S. Dollar – Up And Up

After a prolonged period of ultra-low monetary policy, the US Federal Reserve is likely to be the first major central bank to tighten. This has caused the longest period of dollar strength since the mid-1990s.

O’Nolan said: “As the dollar strengthens, other currencies weaken, making commodities more expensive which further dampens demand.”

Supply Versus Demand: Off Balance

The final factor has been the relatively high levels of supply. O’Nolan said: “Spurred on by the high commodity prices throughout the first part of the millennium, producers increased supply.” But demand has not kept pace, leaving many markets over-supplied.

These three factors made a sizeable allocation to commodities look unattractive for several years. O’Nolan added that he has been underweight commodities across most multi-asset portfolios for the last four years.

But at the start of the year Fidelity started to move from an underweight to a more neutral stance. “We made this change because we saw that oversupply was starting to shrink,” said O’Nolan. The most obvious example was the falling number of oil rigs in the U.S.

However, there has been little change in the other two factors which have dampened commodity prices. O’Nolan said: “Chinese manufacturing remains weak and the dollar remains strong.”

Brighter Long Term Outlook

While it seems unlikely commodity prices will rebound strongly over the near term, the longer term outlook for global staples remains intact.

Martin Arnold, global commodity & FX strategist at ETF Securities, said: “While economic growth is unlikely to continue at the same clip in the next decade as the previous decade in China, the level of demand for resources should remain high and supply may struggle to keep up as commodity producers cut back on expenditures.”

In addition, the rising affluence of citizens in emerging market countries as the industrialisation process continues should lead to greater consumption of finished goods, driving up the global demand for raw materials, added Arnold.