The strong blend of macro forces driving commodities lower makes it unlikely the sector will recover for months to come.
Perhaps the biggest factor has been China, which drove the cycle through boom and now bust. At the same time, the U.S. Federal Reserve could start, as early as next week, to normalize interest rates, which have been at near zero for nearly seven years. That is driving the dollar higher, which in turn weakens commodities prices.
No market has been as widely watched or as influential as oil, the lifeblood of commerce and the one that is most tethered to geopolitics, and now tied to movements in the stock, bond and other commodities markets. OPEC gave oil its latest kick down last week, by retaining its year-old policy of letting the market set prices. West Texas Intermediate crude is now down more than 10 percent since OPEC’s meeting Friday.
“I think it’s the reality that there is no OPEC savior. In fact, there’s no OPEC, for now,” said Daniel Yergin, vice chairman of IHS.
The correction in commodities markets is not new and for some, like gold and copper, it has been going on since 2011. So far this year, iron ore has lost 45 percent, copper has shed 27 percent and oil has lost about 30 percent. Gold is down more than 8 percent this year.
“It’s the backside of the commodities super cycle, ” said Yergin.
China’s boom fed a surge in commodities prices, but its industrial- and construction-based economy is changing and it is seeking to foster more growth in domestic consumption. China’s trade data Tuesday showed a worse-than-expected 6.8 percent drop in exports. Imports fell 8.7 percent, for a 13th consecutive drop. China’s copper imports did jump nearly 10 percent to 460,000 tons and oil imports also rose.
In the middle of all this market mayhem are investors, and it’s the time of year when funds look to clean up positions. Some wrong-way bets have caused serious pain.
“I know a lot of hedge funds fought the tape all year in oil, and especially to the extent that they are getting redemptions, they will have to start liquidating,” said John Kilduff of Again Capital.
Astenbeck Capital Management, a fund run by oil trader Andrew Hall, lost 9.7 percent in November, and is now down 26 percent this year, according to The Wall Street Journal. Astenbeck’s assets under management fell to $2.4 billion from $3 billion at the beginning of the year.
The newspaper said Hall has remained bullish on oil throughout the sell-off in crude and in a letter to investors last week, he remained bullish, pointing to factors that suggest a turnaround is coming soon.
The sell-off in oil is pressuring other commodities. “I think what you’re seeing now is a couple of funds have to get liquid,” said George Gero, analyst at RBC. He said the liquidation is apparent in the gold futures market, where open interest in November was 450,000 but is now 395,000.
“As the market deteriorated, fund managers weren’t able to buy. They had to sell and their shareholders are now selling for the end of the year as well,” he said. The tax selling and deterioration of oil futures combined to escalate the general sell-off in commodities and “it all started with the oil glut.”
Falling oil also makes gold less attractive as a hedge against inflation, said Gero. But he does see the selling in precious metals as overdone and says gold, and possibly platinum and palladium, could begin to move higher after the Fed‘s rate hike, expected Dec. 16.
Strategists do not expect a turnaround in oil until the second half of next year, and they do not project prices to rise much above $60 per barrel for Brent.
Francisco Blanch, head of global commodities and derivatives research at Bank of America Merrill Lynch, said he is expecting Brent crude to average $50 per barrel next year, and WTI slightly less. He sees oil recovering in the second half of the year, with Brent heading to $60.
“The macro picture is still very poor for commodities. Micro dynamics are starting to look a little bit better,” he said. Blanch said weak global growth and the strong dollar are dual headwinds for commodities.
“We think over time, we’re going to see lower supply in a number of markets. It’s important to note that demand for many commodities has held up nicely. That’s the example for crude oil and even aluminum where we’ve had strong demand years in 2015,” said Blanch, who was releasing the BofAML outlook for 2016 on Tuesday.
The market-based strategy pursued by OPEC has in some ways backfired. The cartel pursued a Saudi Arabia-led strategy of letting the market set pricing, and the market has been trying to find a bottom for a year now. Saudi Arabia increased its production but so did non-OPEC Russia and the U.S. and the market is now even more oversupplied.
“It’s basically supply and demand and there’s no market manager. Basically, the message that came out of the OPEC meeting was more of the same. We just didn’t see a basis for an agreement,” said Yergin. “For Iran, on the one hand to call for other people to cut back and on their other hand, to try to get as much oil back on the market as it can, is not a recipe for any kid of deal and there’s zero trust.”
Yergin said the market will likely not stabilize until it’s clear what Iran is able to do to return oil to market, and that is expected in late winter, or spring. Iran has said once sanctions are lifted on its nuclear program, it can bring 500,000 barrels a day to market very quickly.
Strategists are looking to the U.S. for a cut in oil production, as companies respond to the pain of a long slide in prices. That could help balance the market, though U.S. companies are still producing at a rate of 9.2 million barrels a day, after peaking in April at 9.6 million barrels.
Analyst say companies are not well-hedged after the beginning of the year because they did not expect such a long downturn. Bank financing will also be reviewed during the spring and funding could become more of an issue. The result could be more bankruptcies and mergers.
Chevron CEO John Watson, speaking on CNBC Tuesday, warned more pain is coming, and it will result in less production. “If you look at the capital that is being withdrawn from the business, hundreds of billions of dollars are being taken out of the business right now. But what you’re also seeing is some companies are finishing projects that are under construction, so that’s temporarily adding to supply. But once those projects come on line and as people absorb the current prices, you are going to see production drop in many parts of the world,” said Watson.
The weaker outlook for China has also weighed on other emerging markets, which produce commodities. Those economies are also hurt by the stronger dollar, and Blanch expects China and emerging markets to remain headwinds.
“We expect U.S. monetary policy to be on basically a collision course with Chinese monetary policy,” said Blanch. “That means there probably will be too few dollars chasing too many commodities.”
Blanch expects copper to fall below $2. March futures were trading at $2.05 a pound Tuesday. He said the shift in China’s economy from industrial and construction based to more services oriented will continue to have an impact on commodities markets.