Commodities crash was predictable

Allister Heath
SO Goldman Sachs was right after all. The bank everybody loves to hate called the top of the commodities market three weeks ago; yesterday, its prediction came true, with the declines in key commodities seen in recent days suddenly turning into an almighty crash. The price of oil plunged especially dramatically, with Brent crude losing $12 yesterday, or 10 per cent, to trade at around $109 a barrel.

The most shocking slump has been suffered by silver: just a few days ago, it was trading at around $50; it is now back down to $35, having suffered its steepest crash since the 1980s. Since 29 April, silver has crashed 23.3 per cent, LME tin is down 9.8 per cent, palladium has lost 10.4 per cent, gold 4.5 per cent and brent crude 9.1 per cent. In the US last night, the price of a barrel of oil was back below $100. It’s dramatic and highly significant stuff.

It is excellent news for consumers and companies that use raw materials; relentless and increasingly unbearable pressures on costs and prices will now be reduced, at least if commodities remain weaker. But few economists are celebrating. The main driver of the correction was weaker economic data. Markets were especially rattled by weekly US jobless claims that jumped to an eight-month high and the news that the country’s productivity growth slowed in the first-quarter. Other bad figures included all three main UK activity surveys: the purchasing managers indices for manufacturing, construction and services all showed weaker (but still positive) growth in April. Another reason for the sharp fall is mounting fears that China’s monetary tightening will hit demand from the world’s top buyer of commodities; a growing number of other countries are starting to hike interest rates (though the Bank of England once again declined to do so yesterday); and many investors are beginning to realise that many commodity prices are completely out of line with reality.

Jeffrey Currie, Goldman’s influential 45-year-old head of commodity research, announced that he would be closing his erstwhile ultra-profitable long commodities trade made up of a basket of crude oil, copper, cotton, soybean and platinum. He also quit his long copper and platinum positions, arguing that the risk was now too high. His move was revealed on 12 April; many shrugged it off as nonsense. Barely two weeks later, these pundits have egg on their face. Presumably we will now hear all sorts of demented conspiracy theories about how Goldman controls the world – but the simple truth is that Currie called the market right.

The primary drivers of commodity price bubbles are excessive liquidity: too much money chasing too few raw materials. Central banks are always the main creators of liquidity: either via excessively low interest rates or quantitative easing – or through the manipulation of exchange rates and the accumulation of cash piles that put downwards pressure on yields. There is still plenty of liquidity in the global economy – but prices of key commodities such as oil had become so elevated that they had started to choke off demand. With global growth starting to slow after its astonishing post-recession rebound, investors have at last realised that they allowed themselves to get carried away. It is ironic, of course, that speculators are always blamed when commodity prices soar, even when other, larger forces are really responsible – yet they are never thanked when prices collapse.
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