BL: Commodities' Biggest Collapse Since Lehman Fell Signals Bear Market Ahead
By Millie Munshi and Elizabeth Campbell
June 1 (Bloomberg) -- The biggest slump in commodities since Lehman Brothers Holdings Inc. collapsed is undermining Wall Street forecasts for accelerating economic growth and higher prices for everything from copper to crude oil.
The Journal of Commerce commodity index that includes steel, cattle hides, tallow and burlap plunged 57 percent in May, two years after a decline that foreshadowed the worst recession in half a century. The index of 18 industrial materials declined the most since October 2008 as Europe’s debt crisis widened and China took steps to curb growth.
Commodities extended their decline today, led by a 2.9 percent slump in crude oil and 3.8 percent drop in copper, as the rate of manufacturing expansion in China and Europe slowed. The pace of growth in a U.S. factory index is also expected to weaken, according to economists’ forecasts before a report scheduled for later today.
“As risk-taking falls, expected growth is reduced,” said Colin P. Fenton, the chief executive officer of Curium Capital Advisors LLC in Boston, who was a commodity analyst at Goldman Sachs Group Inc. and at Stanley Druckenmiller’s Duquesne Capital Management LLC hedge fund. “Demand for commodities is going to be softer than it might otherwise have been.”
While the Organization for Economic Cooperation and Development raised its growth forecasts for this year and next on May 26, investors are dumping holdings at the fastest pace since February.
Supply and Demand
The Journal of Commerce Industrial Price Commodity Smoothed Price Index reflects clearer signs of supply and demand than futures markets because half the items it tracks don’t trade on exchanges used by speculators, said Lakshman Achuthan, the managing director at the New York-based Economic Cycle Research Institute. The gauge dropped to 25.97 on May 28 from 60.56 on April 30.
In June 2008, a month after the index reached its peak, the Paris-based OECD said the U.S. would grow at a 1.1 percent rate the following year. Commodities continued to drop, and in October 2008, the index fell at a 56 percent annual rate, which was then the lowest level since 1949.
Almost two months later, the National Bureau of Economic Research, the panel that dates American business cycles, said the U.S. was in a recession. The world’s largest economy shrank 2.4 percent, the worst contraction since 1946.
Now, “the collapse in the commodity index is telling us that the peak in global industrial growth is imminent, it’s here right now,” said Achuthan. “Markets are going to have to deal with the reality of a slowdown.”
Manufacturing Indexes Slide
China’s Purchasing Managers’ Index slid to 53.9 from 55.7 in April, the Federation of Logistics and Purchasing said today. That was less than the median 54.5 estimate in a Bloomberg survey of 18 economists. A gauge of manufacturing in the euro region fell to 55.8 in May from 57.6 the previous month, Markit Economics said. The Institute for Supply Management’s factory index in the U.S. dropped to 59 last month from 60.4 in April, according to the median estimate in a Bloomberg survey of 62 economists. The report is due at 10 a.m. New York time.
Europe’s debt crisis is only starting to weigh on global growth, said Michael Aronstein, a strategist at Oscar Gruss & Son Inc. who predicted the 2008 commodity plunge and is betting against a rally this year.
The European Union announced an almost $1 trillion loan package last month to halt a slide in the euro and local bonds that threatened to shatter the currency union. Budget cuts across the region may curb demand for Chinese imports as well as commodities including gasoline, aluminum and steel.
Sagging Demand
Raw materials may drop another 10 percent because the economy is on the “cusp” of deflation, said Philip Gotthelf, the president of Equidex Brokerage Group Inc. in Closter, New Jersey. That would drive the Reuters/Jefferies CRB Index of 19 commodity futures down 22 percent from a Jan. 6 peak and into what investors consider a bear market. The gauge plunged 8.2 percent in May, the most in 18 months.
Gotthelf correctly predicted in October 2008 that oil would fall below $40 a barrel and said he is now shorting most commodities and buying gold.
The S&P GSCI Total Return Index of 24 commodities declined 2.1 percent as of 10:17 a.m. in London, the most compared with closing prices since May 17.
Economic forecasts have been rising. As a group, the OECD’s 30 member nations will grow 2.7 percent this year, the organization said. The expansion will reach 3.2 percent in the U.S. and 10.1 percent in China, according to separate surveys of economists by Bloomberg last month.
Fundamental Strength
“The market is underestimating the strength of the fundamentals and overestimating the impact that the European sovereign-funding issues will have on growth,” Jeffrey Currie, a Goldman Sachs analyst, said in an interview from London. He says the decline is a “buying opportunity.”
Freeport-McMoRan Copper & Gold Inc. Chief Executive Officer Richard C. Adkerson told analysts on a conference call May 11 that while “there is still a lot of uncertainty” about the world economy and its reliance on demand from China, the Phoenix-based mining company sees “some pockets of demand improvement” and is taking steps to ramp up copper production.
“There are headwinds, concerns both in Europe and in Asia that are making investors rethink their decisions and maybe take some profits, but I believe that the longer-term growth story remains intact,” said Michael Cuggino, who manages about $6 billion at Permanent Portfolio Funds in San Francisco. “I don’t think it’s a broader slowdown. I think it’s a correction.”
Lower Prices
Inflation is almost non-existent. In April, U.S. consumer prices unexpectedly dropped 0.1 percent, the first decrease since March 2009, government data show. In the 12 months ended in April, the cost of living rose 2.2 percent, following a 2.3 percent year-over-year gain in March.
Bank of America Merrill Lynch says prices will continue to deteriorate. On May 25, the Charlotte, North Carolina-based bank cut its oil forecast for the second half of the year to $78 a barrel from $92. Doane Agricultural Services Co. in St. Louis said May 18 that corn will drop 14 percent by October to $3.25 a bushel. Corn for December was at $3.7625 today.
Copper, a commodity former Federal Reserve Chairman Alan Greenspan saw as an economic indicator, declined 7.4 percent in May, the biggest monthly slide since January, and traded at $3.0295 a pound at 10:12 a.m. London time today. Burlap, used for industrial packaging, is down 9.7 percent this year, almost matching its 9.9 percent drop in 2008.
Manufacturing Risk
“If commodity prices are coming down, there is some downside risk to the manufacturing sector,” said Chris Rupkey, the chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York. “It’s too early to see it in people’s numbers yet, but if I had to guess, people will shave their estimates” for growth this year, he said.
Commodities last fell into a bear market in 2008, when the CRB plunged 56 percent in five months as the U.S. suffered the worst financial crisis since the Great Depression, growth contracted on a global basis for the first time since 1981, and the Journal of Commerce index was below zero.
Now, a slowdown in Europe, the biggest destination for Chinese exports, will “badly hurt” the Asian country, said Lewis Wan, the chief investment officer for Pride Investments Group, which oversees $150 million in Hong Kong. The Shanghai Stock Exchange Composite Index tumbled 21 percent this year as the government enacted measures to cool its property market.
As of last month, the European Union’s economy was expected to grow 1.1 percent this year after contracting 4.1 percent in 2009, the biggest drop since 1992, according to 19 economists surveyed by Bloomberg.
Euro Outlook
A “wave of fiscal austerity” in Europe will depress the expansion in the region, in the U.S. and in China, according to Arnab Das, the head of global market research at Roubini Global Economics in London. The euro on May 19 dropped to $1.2144, its lowest level against the dollar since April 2006, as Spain was forced to rescue banks and policy makers including Italian Prime Minister Silvio Berlusconi said they would cut spending to combat a financial “tsunami” in the region.
Investors are getting less bullish, according to the U.S. Commodity Futures Trading Commission. Speculative net-long positions, or bets on rising prices, for 16 commodity futures have dropped 33 percent in the past three weeks, CFTC data show. That’s the lowest level since Feb. 9, after the net-longs plunged 58 percent from a 20-month high on Jan. 12.
“It’s the uncertainty that’s the biggest problem,” said John Kinsey, who helps manage C$1 billion ($995 million) at Caldwell Investment Management Ltd. in Toronto. “Commodities are being attacked with these concerns about the debt situation in Europe and the steps that China has taken to tighten. People are afraid this is going to slow the economy. It’s hard to see a way out of it.”
To contact the reporter on this story: Millie Munshi in New York at mmunshi@bloomberg.net; Elizabeth Campbell in New York at ecampbell14@bloomberg.net.
Last Updated: June 1, 2010 06:04 EDT
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