Commodity prices have lost some of their shine in recent years, with falling prices reflecting a broader economic malaise and a shaky outlook for Chinese growth and demand.
Since its peak in February 2008, the Bloomberg Commodity Index, which measures a broad basket of commodities, has fallen 62 per cent. However, there are signs that this bear market is beginning to burn out, with prices rallying 14 per cent so far this year.
There is little reason to expect a dramatic rebound in commodity prices from here. But if the market is now past the worse, there will be important implications for commodity producers, emerging markets and the medium-term inflation outlook. Commodity prices have begun to tick up since the turn of the year. But are there further rises in the pipeline?
Eight years of falling prices have triggered significant production cuts in many commodities. From the summer of 2014 to the end of 2015, oil firms cut capital expenditure by $385bn (£298bn) – equivalent to 3m barrels a day of production being delayed until after 2020.
Supply cuts have supported prices for some commodities, but not across the board. The outlook for industrial metals remains fairly bleak due to significant supply overhangs from China and other markets. This raises the prospect of increased divergence in price performance across different commodities in the months ahead.
Falling commodity prices have acted as a disinflationary force in recent years. Inflation since the financial crisis has averaged just 1.2 per cent, versus 2.0 per cent in the years leading up to the crisis. But now the drill is changing, with prices beginning to well up again – and these disinflationary forces are likely to become inflationary pressures. If the oil price were to end 2016 at $50 a barrel, this would represent a 37 per cent increase since the end of 2015. This has begun to feed through into inflation forecasts, which are expected to pick up sharply for the major developed economies over the course of the year.
The prospect of higher inflation is unlikely to trigger a response from interest-rate setters in the near term. A little inflation – after years of inflation undershooting – may in fact be welcomed by central banks as a much-needed boost to nominal growth.
The prospect of higher inflation is unlikely to trigger a response from interest-rate setters in the near termEmerging market (EM) assets have been particularly vulnerable to the slowdown in commodities due to the high weighting of commodity exports in EM indices. Approximately 28 per cent of EM equities and 58 per cent of EM debt is exposed to commodity-exporting nations, such as Brazil and Russia.
The valuations of EM equities are close to historic lows, with the price/book (P/B) ratio for the index at 1.4x – one of the lowest levels since 2009. P/Bs of this level have historically often fuelled double-digit returns over the subsequent 12 months. Coupled with these low valuations and the heavy sell-offs in many EM currencies, the potential end to the commodity bear market has increased the attractiveness of EM assets in recent months.
Some parts of the commodity market are rebalancing faster than others. This is likely to produce increased divergence in performance, with commodities unlikely to move as one homogenous block. Higher commodity prices spell higher inflation, but stronger price pressure could come as a welcome surprise for many investors after so many years of disinflation. Central bankers are also likely to tolerate some above-target inflation in the near term. It is early days. But a bottoming-out – and potential recovery – in at least some key commodity markets could allow some unloved resource companies and asset classes, such as EM equities, to begin to regain their lustre as earnings expectations improve.
Nandini Ramakrishnan is a global market strategist at JP Morgan Asset Management
