Commodity madness upends the global order

A month ago it would be hard to conceive that world tourism would be all but dead, Lufthansa would cut half its flights and a quarter of Italy would be placed under quarantine. Cruise ships are berthed and lying empty. Public meetings are being cancelled, and the much-maligned ‘gig economy’ is surging as people work from home to avoid the coronavirus.

These are strange times indeed. So much has changed in the last few weeks that it’s likewise hard to imagine SA’s economy reaching the 0.9% growth projected just two weeks ago during Tito Mboweni’s Budget speech.

Commodities are entering dangerous territory, lead by Brent crude oil’s 24% drop on Monday to $34/barrel. Zinc, tin, coal, steel and aluminium have been hammered over the last six months – long before the world had even heard of the Covid-19. Aluminium is down nearly 40% since its 2018 peak of $2 603 a tonne. Steel rebar is down 20% in the last six months, and coal 30% over the same period, reflecting a cooling in global industrial production. Taking their lead from oil, all industrial minerals booked losses on Monday.

Gold is the one notable exception to the market chaos.

It shot above $1 700 an ounce on Monday, with Goldman Sachs now penciling in a price target of $1 800/oz, while others see $2 000/oz as a likely target within the next two years.

China’s commodity imports have held up surprisingly well, despite the partial suspension of economic activity due to public health concerns. Stockpiles of aluminium have risen sharply as commodity imports that cannot be exported are routed straight to inventories. This may reflect the difficulties in suspending and then restarting smelters, according to Capital Economics.

In 2007, options trader Nassim Nicholas Taleb wrote The Black Swan, pointing out that massive social and market impacts are often unpredictable and unforeseen. The black swan event of the last two weeks was the exponential spread of Covid-19 beyond China, with close to 117 000 people infected worldwide and more than 4 000 fatalities. Even though the rate at which the virus is spreading in China is declining, Taleb argues it is better to over-react than hope for the best.

Saudi Arabia had wanted to lead the Oil Producing and Exporting Countries (OPEC) in cutting production as a way of supporting oil prices, which have been under pressure due to the virus outbreak. As Ft.com reported, Russia was not interested, arguing that it wanted to assess the full impact of the coronavirus before taking action.

Saudi Arabia’s oil production gamble may be counter-productive, as it relies on oil exports to sustain a soaring fiscal deficit. Russia, with a production cost of about $7/bbl, can sustain an oil price war for years. US oil fracking producers, with average costs of around $50/bbl, could soon be filing for bankruptcy, which would be sweet revenge for Russia after enduring years of US-instigated sanctions. 

Some fundamental global shifts are in play here: oil prices crashing, zinc and tin (reflecting global industrial demand) back to where they were in 2010, yet gold and rhodium surging. This shows the skittishness of the world right now.

This is reflected in the Bloomberg Commodity Index, a basket of 22 commodity futures in seven sectors. The index is at it lowest level in a decade.

Source: Bloomberg (as of March 10)

The plunge in oil prices may not last, according to Capital Economics, which sees crude oil prices settling at $48/bbl by the end of 2020. Both Saudi Arabia and Russia can sustain a prolonged price war, even though their current accounts will swing into deficit.

On the flip side, lower oil prices will benefit countries like SA and Turkey, but the gains will be small. “And with consumers reducing discretionary spending due to coronavirus fears, most of the windfall from lower oil prices will probably be saved rather than spent,” says Nikhil Sanghani, assistant economist at Capital Economics.

On Monday the rand traded just shy of R16 to the US dollar, a level last seen in 2015. This reduces the chances of further interest rate cuts in the short term, given the potential to further damage the currency. In the developed world, rate cuts are more certain, as virtually the only tool left in central banks’ arsenal to reboot economic growth.

Monday was the worst day for the stock market since 2008.

Read: A bloodbath like the JSE hasn’t seen in 10 years

The benchmark S&P 500 Index fell more than 7% on opening, triggering a mandatory trading halt on the New York Stock Exchange, to give investors time to digest what was going on. According to Stansberry Research, we are now within a whisker of calling an end to the record-long bull market.

The S&P 500 has fallen more than 18% from its most recent high of 3,386 on February 19. It was down 7.6% on Monday, and if it closes at or below 2,708, we will then have entered bear market territory.

“On the other hand, if the bull keeps running, it will be an epic comeback,” says an investor report from Stansberry Research.