This analysis is by Bloomberg Intelligence Senior Macro Strategist Mike McGlone. It appeared first on the Bloomberg Terminal.
Commodities have pulled back from the 2022 spike, and it’s a question of whether there’s recovery or enduring declines from here. Our bias is the latter. That the primary source of heat, electricity and fertilizer in the US — natural gas — dropped in 1H to levels first traded in 1990 highlights deflationary forces. Crude has similar attributes, as advancing technology pressures prices from both sides of supply and demand. The biggest-ever liquidity pump is reverting at a breakneck pace, and most central banks are still tightening in 3Q despite collapsing US producer prices, with headwind implications.
Relying on China stimulus for commodity buoyancy may prove comparable to the disappointing post-lockdown recovery. Gold appears as a bullish outlier, particularly if US equities back up for an economic slowdown.
The aftermath of the most aggressive global central-bank tightening in history, with Europe leaning into recession and diminishing economic growth in China, could burden commodity prices. Bounces are to be expected, but we see reversion lower as the more likely commodity path into 2024.
New highs back to old lows: What stops it?
The commodity market may be at greater risk of revisiting the pre-pandemic lows than last year’s highs. Our graphic shows how straightforward this is, with the Bloomberg Commodity Spot Index peak from 1980 as a guide. What’s notable in commodities is the high price cure is typically an enduring force, and potentially more so after the 2021-22 near-perfect rally. The spike occurred on the back of extraordinary global liquidity supply and gained fuel from Russia’s invasion of Ukraine, and history may show it coincided with peak China, akin to the collapse of the Soviet Union and Japan bubble about three decades ago.
Our graphic shows bearish commodity and risk-asset implications from plunging US money supply and yield curve. Consensus at July’s end is that the US will avoid a recession, and that may tilt risks the other way.
Gold beating commodities looks likely to endure
The dichotomy between the world’s largest economy and importer aggressively hiking rates to squash inflation (the US), and the the biggest exporter (China) cutting rates to spur demand may suggest early days for a lower trajectory in commodities. Our graphic shows the Bloomberg Commodity Spot Index (BCOM) spike along with an unprecedented US money supply surge to the 2022 peak that’s now unwinding. Markets fueled by excess liquidity often see a slide once that glut reverses, and it’s a question of how much and for how long.
The BCOM is about on track with money supply since the end of 1999, emphasizing the propensity for dollar-denominated assets to advance because of the supply of the currency. What’s notable is the deflationary nature of broad commodities as shown by the greater appreciation in the price of gold.
Is this the transition stage to deflation?
The stock market at the top of our annual performance scorecard vs. commodities at the bottom show some reversion of 2022, but its a question of duration. Our take is broad commodities are unlikely to rise with the stock-market tide, due to the high correlation with Fed rate hikes. Some normal retracement of the roughly 20% of S&P 500’s advance in 2023 to July 28 may be a primary risk to commodities.
We’re concerned that risk assets might be in a temporary state of optimism due to disinflation, but deflation is common in recessions and it may be early days. The producer price index finished-goods gauge at minus 3.1% has dropped at the greatest pace since 1948 from 2022’s 18.3% peak. Booms and busts are typically coincident with revolutionary technologies and liquidity, which may lean to Bitcoin as a leading indicator.
Commodities signal trajectory toward recession
Precious metals on the top of our annual performance scorecard vs. industrials and energy toward the bottom can be a recipe for a global economic slowdown. What stops these bodies in motion at the end of July is a key question, and the Fed and most central banks still tightening isn’t a positive catalyst, if the rules of liquidity and economics apply. Bloomberg Economics’ downward-revision trend in China’s economic growth is a headwind for crude oil and copper. Substantial fiscal and monetary stimulus from the world’s biggest commodity user may be necessary to reverse the price decline. That’s especially so with Europe, a top Chinese-export customer, possibly sliding toward recession.
We believe broad-based commodities are more likely to bottom with a lag to central-bank easing following a recession.
Bloomberg
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