A decade-old commodity boom came crashing down to a disastrous ending in Q’4 of 2015, and pushed many energy and mining companies to the brink of default on their debts, as China’s industrial output and appetite for raw materials slowed to half the growth rate of 2005 – 2008. The Thomson Reuters Core Commodity Index ended -25% lower last year, to hit its lowest level since 2002, as commodities ranging from iron ore to crude oil took a battering. And there were few bright spots in sight. The Fed was threatening to lift the fed funds rate by a total of +1% by year’s end 2016; and thereby, buoy the US$ and making many commodities more expensive for international buyers.
Among industrial commodities, iron ore prices tumbled -40% last year due to global oversupply and shrinking Chinese demand, for a third year of losses. In coal, thermal prices fell almost a third in 2015, hurt by waning Chinese demand and the rise of renewable energy. Both iron ore and coal fell -80% in value since their respective historical peaks in 2011 and 2008. Benchmark oil and natural gas prices also slumped, down a third this year and -70% since the rout began in July 2014. Copper and zinc shed a quarter of their value, and nickel collapsed more than -40% hammered by slowing growth in top consumer China. The dire outlook was expected to trigger a fight for survival across the supply chain, including shippers and private oil drillers, while oil-dependent countries from Venezuela and Russia to the Middle East faces much smaller revenues. “Headwinds are growing for 2016,” Morgan Stanley warned, citing increases in global supply and a slowdown in demand, reflecting a market consensus that meaningfully higher commodity prices were not expected before late 2016.
As such, the 4-1/2 year Bear market slide in commodity prices, also greased the skids under a multi-year long sell off in Emerging market <EM> currencies, and EM bonds and stocks. EM bond spreads over US Treasuries blew out to +514 basis points (bps), the highest in almost seven years. For many EM countries, the sale of commodities, is a key export item and top generator of foreign exchange for the central bank, and top generator of tax revenues for the state government. With the price of Russia’s Urals blend of crude oil sliding below $35 /barrel, Russia’s rouble collapsed by more than -60% to a new record low.
South Korean foreign exchange authorities were suspected to have sold around $2-billion in February; to prop up the Korean won shortly after it fell to a 5-1/2 year low against the US$; issuing a stern warning against herd behavior. Even though Korea has few natural resources, it is one of the world’s biggest exporters of refined petroleum products and steel.
There was a -20% rout in China’s stock markets in January, that triggered circuit breakers and a 15-minute halt for stocks, options and index futures, after limit down moves of -7%, and suspended trading for 3-days. A gauge tracking 20 Emerging-market currencies slumped to an all-time low. Malaysia’s ringgit and Indonesia’s rupiah were hard hit, and the US$ rose to above 4-Brazilian reals. China’s stockpile of foreign-currency reserves plunged $513-billion last year to $3.33-trillion, the first annual drop since 1992, as Beijing worked to prop- up the yuan. Last year’s capital outflows from China compares with a figure of $1 trillion estimated by Bloomberg Intelligence. The Institute of International Finance detected net capital outflows of $735 billion that was withdrawn from all of the Emerging markets in 2015.
Still, as of mid February, Commodity Bears were testing the nerves of producers. Several commodity producers, ranging from base metals, energy, dairy in New Zealand, rubber in Thailand and shale oil in the US, had yet to blink and cut production in a meaningful way to remove surpluses. The Total Return Commodity Price Index has tumbled to a 13-year low, with base metals at 7-to-8 year lows, crude oil at 12-year lows. Commodities like iron ore, steel and coal were crushed, dropping by more than half from their 2011 peaks, largely due to increasing supplies and a slight dip in demand.
However, Commodities have long cycles of weakness and strength driven by demand/supply, and commodities have an intrinsic value. Commodities have a cost of production, and there is a limit to how much that any company can produce, if prices are staying below the cost of production over an extended period of time. As such, a trough for a nearly 5-year Bear market for commodities might have been reached in February. Since then, the Equally Weighted Commodity Index <EWCI> has turned upward by roughly +10% above its multi-year lows.
Likewise, the Wisdom -Tree Emerging Currency Strategy Fund; <ticker CEW>, has also turned upward, moving in sync with the commodity index, and closing around $17.75 /share today. CEW includes a basket of equally weighted currencies, such as the Mexican Peso, Brazilian Real, Chilean Peso, Colombian Peso, South African Rand, Polish Zloty, Russian Ruble, Turkish New Lira, Chinese Yuan, South Korean Won, Indonesian Rupiah, Indian Rupee, Malaysian Ringgit, Philippine Peso and Thai Baht.
A new round of concerted easing by the world’s top central bankers might have helped to turn the bearish tide, and provided enough fuel to lift commodity prices higher in recent weeks, led by the likes of crude oil, gold, iron-ore, and copper. On January 21st, the People’s Bank of China <PBoC> injected more than 600 billion yuan into the money markets and on Feb 29th, the PBoC resumed its easing campaign, by injecting an estimated $100-billion worth of long-term cash into the economy; by cutting the reserve requirement ratio <RRR>, or the amount of cash that banks must hold as reserves, by -50 basis points, taking the ratio to 17%for the biggest lenders.
On Jan 29th, the Bank of Japan <BoJ> unleashed a three tiered version of the Negative Interest Rate Policy <NIRP>, while keeping its nuclear option – an expansion of its monthly liquidity injection, via QQE, on ice for a later date. The shift to NIRP pushed Japan’s 5-year bond yield below Zero percent for the first time! In addition, the yield on Japan’s 10-year JGB fell to -10-bps in March. Nearly $7.5-trillion of government debt worldwide is yielding less than Zero percent.
On March 10th, the European Central Bank <ECB> beat expectations by ratcheting up its monthly bond buying under quantitative easing by €20-billion to €80-billion. And most recently, on Mar 14th, the Federal Reserve revised its projections for interest rates in 2016, aiming for 2-rate hikes this year, instead of 4-rate hikes telegraphed earlier. On March 29th, Fed chief Janet Yellen said the next change in the Fed’s monetary policy should be implemented “cautiously,” given the growing risks for the global economy, particularly the expected slowdown of the Chinese economy and the drop in commodity prices.
As such, Bloomberg Dollar Spot Index, which tracks the greenback versus 10 major peers, (including 5 Emerging currencies) slumped more than -4% this month. That was very surprising, because several Fed policy makers including St. Louis Fed chief James Bullard, Atlanta Fed chief Dennis Lockhart, Philly Fed chief Harker, and San Francisco Fed chief John Williams all warned that a +25-bps rate hike to 0.625%, was likely, as soon as April 26th. However, since Yellen spoke on March 29th, traders have cut the likelihood of a move by the April Fed gathering to zero, and lowered the probability of an increase in June to 24%.
In a new effort to dispel anxiety about China’s cooling economy, the central bank governor said on March 14th the country can hit this year’s official growth target and Beijing has no need to weaken its currency to boost sagging exports. Zhou Xiaochuan’s comments at a news conference during China’s national legislature add to a high-level public relations campaign by Beijing to reassure global financial markets about the stability of the world’s second-largest economy following stock and currency turmoil. Zhou expressed confidence the economy can hit its official growth target, which the ruling Communist Party lowered this year to +6.5% to +7% from last year’s +7%.