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The Real Story Behind The Commodities Price Rebound

China, Company Strategy, Economics, Oil & Gas, US
By John Richardson on 03-Mar-2017


By John Richardson

THE job of anybody involved in financial markets, whether equities or commodities, is to of course make money – whether by going long or short. What matters, therefore, is not whether an economic theory ultimately turn out to be true or false. All that matters is that the theory moves markets in the direction that people want in order to make money.

Everyone’s knows that, surely? But I worry that today’s euphoria around the rebound in oil and iron-ore prices etc. is causing temporary amnesia amongst some of those people whose job it is to sell real things of lasting value – including chemicals and polymers. The other week I for instance heard from a chemicals sales manager that a story is doing the rounds that we are entering a new commodities supercycle.

Let’s look at the evidence against that proposition, starting with today’s levels of speculation.

Record Levels of Speculation

  • Hedge funds on February 24 set a new record for net long positions in WTI crude futures. This followed the previous record, set in early February, for long speculation as a whole in the oil markets.
  • China has launched an investigation into local iron-ore speculation that it believes is a significant factor behind the return to producer-price inflation in China. The fact that the top legislative body, the National Development and Reform Commission, is behind this probe reflects its seriousness. There are also reports of high iron ore stock levels in China.

A great many people have, as a result, bet an awful lot of money on keeping these rallies going. This has become a “self-fulfilling prophecy”, where every piece of positive news is being seized upon in an attempt to perpetuate the upturn. And today, of course, technology plays a much-bigger role in shifting markets in either a positive or negative direction. As I wrote in early February:

Hundreds of millions of dollars can be moved in and out of oil and other commodity markets in a fraction of a second, based on nothing more than the number of re-Tweets of a story on Twitter. These algorithms are not designed to assess whether a story is true or not because they are built for speed and momentum trading.

How This Could Unwind


The above chart shows how US crude-oil inventory levels have just hit a new record high, which is likely partly the result of increased shale-oil production. As we know, shale-oil production costs keep falling and so US producers have every incentive to pump, pump and pump again.

Right now, OPEC is complying with its cutbacks. But how long will this last if the US shale-oil industry starts winning back market share?

There is obviously also the long-term negative demand pull taking place in oil markets – and in markets for all the things made from.

Plus, here are two other points that apply to commodity prices in general:

  1. The real China story, which I will look at in more detail on Monday. In summary here, economic growth was last year boosted by an unsustainable renewed rise in credit that will be unwound in 2017 now that President Xi Jinping has regained control of the economy. One of the many effects on this unwinding will be less speculation in iron ore and real estate etc. as China once again steps up its “whack-a-mole” game.
  2. The froth in equities and commodities has largely factored in a boost in US GDP growth from major tax cuts and big infrastructure spending in the US. But I don’t think either will happen in 2017, as I shall explore in detail in my post next Wednesday. Once the penny drops, money will leave stock markets and commodities.

And Bhanu Baweja, head of emerging markets cross-asset strategy at UBS, makes some very valid points in the Financial Times when he argues that commodities price rises have been supply rather than demand drive – e.g. of course the OPEC cuts and strikes at the world’s biggest copper mine in Chile.

He also note, quoting the FT directly:

Aggregated according to purchasing power parity, the GDP of all emerging economies combined is expected to rise by only half a percentage point in 2017. Any improvement is entirely attributable to Brazil, Russia, Argentina and Venezuela — the first of those is emerging from two years of recession, the second is hit by sanctions and the last improving its annual GDP growth rate from minus 10% to minus 5%.

Once again, please, please be careful out there.