Commodities have been a crushing long trade, with the latest rout taking oil below $50 a barrel, and the commodity currencies to six year lows. They are not the only victims, with gold, copper, iron ore, mining stocks and soft commodities also casualties in a rollover that some are calling a second wave meltdown.
The falls are so extreme that market watchers are forced to reach for long-term charts to provide context. The Australian dollar last traded below $0.74 in 2009. Is this now a very low entry point or a value trap? If the Aussie can ever reclaim the $1.10 it notched up in 2011, it would appear to be a tremendous buying opportunity. Or if the low point of $0.60 tested post crisis in 2008 is again possible, the currency could remain a soul-destroying trade. This is the conundrum facing those who might be tempted by a get rich quick trade on commodity plays.
The bears are queuing long and thick on commodities as supply continues to outstrip demand. Mining giants have fought aggressively for market share by keeping production high while extracting cost efficiencies. Few believe prices have floored, as the miners simply have not slashed capacity enough.
“We’ve been in a multi-year bear market with China’s structural rebalancing still happening. We haven’t seen a meaningful turnaround in commodity prices,” said Michael Widmer of Bank of America Merrill Lynch Global Research. “I’m not sure we are at the bottom,” said Mark Cutifani, chief executive of Anglo American about commodity prices.
Rival Lonmin provided shock value on Friday with its decision to cut production by 100,000 platinum ounces over the next two years. It was a decisive move Widmer believes other miners will have to mimic to restore balance in markets.
Widmer also predicts further interest rate cuts by the Chinese central bank will have little impact on demand. Rate cuts elsewhere could also reward those short commodity currencies. Nomura sees the Reserve Bank of Australia reducing interest rates from a record low of 2 per cent to 1.75 per cent, and Charles St-Arnaud from the bank’s global FX strategy team predicts the Aussie will fall to $0.70 by year end.
Are central bankers merely using the tried and tested method of verbal intervention, jawboning currencies lower with the prospect of lower interest rates without actually moving the lever? How much more of a dip can rates take without triggering a bubble in housing markets? At current levels, lower currencies are already lifting inflation as imported goods become more expensive. In the case of Australia, core inflation is now in the Reserve Bank’s target zone of 2 to 3 per cent, which should remove the incentive to lower rates further. Jeremy Stretch, head of FX strategy at CIBC, believes the market will shore up its views on another rate cut if Australian capital expenditure is weak next month.
“The Aussie dollar could easily fall below $0.70,” said Stretch. He explained that the prospect of higher US interest rates also favours going short Aussie, but added an opportunity to buy could emerge later this year. “Once you get through the first Fed rate hike it might be the time to accumulate some cheap Aussie,” he added.
Others are not perturbed by the current volatility in commodities. Former Bank of England rate setter Ian Plenderleith, current chairman at BH Macro, sees commodities as an important part of a diversification mix in an investment portfolio and has exposure.
But commodities remain a contrarian trade and, worryingly for the risk takers, there may be little short-term reward.
City A.M.'s opinion pages are a place for thought-provoking views and debate. These views are not necessarily shared by City A.M.