Daniel Lacalle: The Bear Market in Commodities
By Daniel Lacalle
For many traders, it was a shock to see the barrel of oil collapse to 12-month lows in June, despite an agreement from producers to cut supplies. However, not many people are talking about the falling prices in other commodities, as well as the positive impact of low oil prices on global growth.
So why is a barrel of West Texas Intermediate still trading for below $50? The problem is not just due to oversupply, but also to a slowdown in the growth of Asian demand. Chinese demand has supported prices for the past decade, as demand in developed markets has reduced thanks to increases in efficiency, substitution, and technology.
However, China’s stockpiles have risen to 511 million barrels in capacity, just below the 693 million barrels the United States held in March. Chinese industrial demand is also falling, due to rebalancing away from the industrial sector and toward services.
But oil prices, in this context, are just a symptom of a much more severe illness: the excess debt and overcapacity created in China to support an unsustainable growth model.
In the first five months of 2017, China has added more debt than the United States, United Kingdom, European Union, and Japan combined. While GDP growth looks healthy as is, it appears weak and potentially dangerous when compared to the increase in the money supply. As the old economy tapers off, fewer and fewer raw materials will be needed for production.
Low oil prices have knock-on effects on other emerging markets. Commodity producers like Mexico and Saudi Arabia are facing another “sudden stop”: the abrupt reduction in U.S. dollar inflows, as debt repayments in foreign currency escalate.
Most economic growth estimates for 2017 were made using much higher oil prices, and the market is likely to see downgrades in expectations of inflation and growth in the majority of the large emerging economies. We are already seeing significant downward revisions for Brazil, Argentina, Russia, and other economies.
According to ICBC Standard Bank, emerging market debt maturities through 2020 will exceed $1.4 trillion. At the same time, as rates rise in the United States, capital flows to emerging markets are much lower than those seen in the past decade. Low interest rates may mask these risks in the short term, as central banks are increasing the money supply by more than $200 billion per month, but they do not eliminate them.
Not Just Oil
There is another factor beyond oil prices worrying investors. Copper prices, a major indicator of global economic activity, continue to be weak due to oversupply and lower Chinese demand.
Market expectations for revamped growth and higher inflation in 2017 and 2018 stand at odds with the decline in major commodities like copper and oil. More importantly, the decline might be a warning sign of a much deeper problem. The more than $20 trillion in monetary stimuli globally has delivered disappointing growth, as well as contagion risk as financial imbalances across countries rose.
Low oil and commodity prices benefit the users of such commodities like the United States and Western Europe. However, given their negative impact on weaker emerging economies, their price decline may be the canary in the coal mine for the world economy.
Daniel Lacalle is a professor at IE Business School in Madrid, a fund manager at Adriza International Opportunities, and the author of “Escape from the Central Bank Trap.”