The commodity markets are tumbling. Gold, oils and almost all the other commodities are immensely depreciated. It may be seemingly explained by the Fed’s rate hike and the slowdown of the Chinese economy, but the two following factors can’t be explained by them:
- The prices are radically falling even in the currencies with the quantitative easing, such as the yen and the euro.
- The prices have fallen to the range before the US started the QE after the financial crisis in 2008.
Although the Fed has surely stopped the QE, they haven neither sold the purchased bonds nor raised the interest rate. If, in addition, the Bank of Japan and European Central Bank stopped the QE, the commodity prices could tumble further, so that what has happened after the massive QE is the deflation. It would be very unreasonable, and so investors need to conceive a reasonable explanation for it.
The price changes of the commodities
First of all, we review how the commodity prices changed so far. The following is the prices after the financial crisis in 2008, at their peak in around 2011 and at the moment.
- Gold: $700 -> $1900 -> $1100
- Crude oil: $30 -> $150 -> $45
- Natural gas: $2.5 -> $7 -> $2.7
- Copper: $1.3 -> $4.6 -> $2.3
- Iron ore: $60 -> $190 -> $45
In terms of the fundamentals, crude oil and natural gas are oversupplied by the US shale industry. Iron ore is affected by the demand decrease in China and the major firms’ production increase. Copper is subject to the slowdown of the Chinese economy. Gold, on the other hand, has increased its production cost, which is supposed to support the price.
Only gold is a buy but not yet
Accordingly, we now know that only gold is moving due to a reason of the financial markets, not the real economy. The production cost of gold is now around $1000-$1200, and it’s not very likely to decrease. This is why we could buy gold when it goes down, but the time is yet to come, as is explained in the following article:
The meaning of the price fall
May we simply regard the tumbling commodity market as the cost reduction for industries that would support the economic growth? Why haven’t the commodity prices gone up, despite the worldwide quantitative easing?
One of the convincing assumptions is to consider the global economy would have been much more horrible without the QE, which implies that the potential economic growth is actually very low, and the US GDP growth of 2%, which the US finally achieved, was actually supported by the massive artificial liquidity that flowed into the economies.
This assumption means that we can’t evaluate by P/E whether the market is too overheated or not. P/E is the stock price divided by earnings, but the assumption means the earnings were made up by the artificial liquidity.
This happened in 2008. Before the financial crisis, the stock markets weren’t too overheated in terms of P/E, but once the liquidity created by debts was gone, the earnings of companies dramatically decreased and consequently their P/E was immensely hurt only after the bubble collapsed. If the commodity market continues to tumble, it could mean that the same thing is going to happen after the worldwide QE ends.
Where is the money flowing into now?
After the money is withdrawn from the commodity markets, where is it flowing into? That’s the stock and bond markets. Much of it could be just preserved as cash, some of it also has to flow into the financial markets, unless the central banks absorb the money.
As the bond yields are significantly low, the stock markets are benefiting from it the most. The money can’t go elsewhere and is just flowing into the risk assets. This is called portfolio rebalancing, which we explained in the following article:
However, this won’t last forever. When the worldwide QE ends, the bonds and the stocks will finally start to fight over money, and the central banks will have to admit they can’t stop the easing.
At this point, all the trends will be reversed. This is where we should buy gold.
Yet, the collapse of the QE bubble will be delayed as the interest rates will remain low in the developed countries even after the Fed’s first rate hike, due to the low economic growth the commodity market indicates.
Great investors such as Jim Rogers and Bill Gross have been insisting the same thing, and there is some valid reason for this assumption. Investors have to be vigilant, watching the commodity markets and the bond yields very carefully.