Is It The Beginning Of A Multi-Year Bull Market In Commodities?

Can you imagine losing $32 billion in just a couple of years? This actually happened to Brazilian businessman Eike Batista.

He believed that growth in emerging markets, especially in China, would create a huge demand for all sorts of commodities. If that sounds familiar, it’s because that was the consensus back in 2012.

So, he built an empire around the sector. For instance, all of his companies were commodity-based businesses, including an oil driller, a mining company, an electricity producer and a port operator. His strategy worked brilliantly during the great bull market in commodities. In 2012, when he was worth $32 billion, he famously said, “I will be the world’s richest man.”1

What Batista didn’t know at the time was that the great bull market in commodities was over and that China wouldn’t turn out to be the picture of ever-increasing demand that people thought it would be. Since 2012, the CRB commodity index has plunged as much as 50%. Four of Batista’s companies have gone bankrupt as falling gold and iron ore prices destroyed his commodities empire. Today, he’s known as “the negative billionaire” because he owes creditors $1.2 billion.2

Batista is certainly not alone. Many other investors have fallen victim to the great bear market in commodities over recent years. According to the rating agency Moody’s Investors Service, companies in the oil & gas sector accounted for 32% of all corporate defaults last year, and metals and mining companies accounted for about 14% of total defaults.3

From Alpha Natural Resources, a leading producer of coal, to Swiss-based Ukrainian iron ore firm Ferrexp and rare earth miner Molycorp – they have all filed chapter 11.4 As for oil and gas, 2015 was the worst year since 1986, when defaults topped 8.3%.5 According to The Wall Street Journal, more than three dozen energy companies have recently declared bankruptcy.6

I’m telling you these stories because all of these bankruptcies may actually be good news for commodities. This is how the economy works. It’s this bust that could help fix the excesses that accumulated during the boom years. Smaller companies with higher debt go bankrupt. Bigger companies survive, but they’re forced to drastically cut production. This will help reduce supply, which will eventually help create a bottom in commodity prices.

But, there’s another factor that could help a recovery in commodities.

How Central Bankers Are Giving Commodities An Extra Boost
Just three months ago, members of the Federal Reserve sounded confident about the economy. They not only raised short-term rates for the first time in nearly a decade, but also said they would increase them again four more times this year. They even predicted 18 more rate increases over the next three years.

But, that all changed this month. As readers of the Daily Pfennig® newsletter probably have heard by now, in its March policy decision, the Fed decided to leave short-term interest rates unchanged. Fed officials also said they now expect to increase rates just two times this year.

According to its official statement, the Fed decided to adopt a cautious stance on the U.S. economy because “global economic and financial developments continue to pose risks…[and] inflation is expected to remain low in the near term.”7

The Fed is not the only central bank taking measures to stimulate the global economy. This month, the European Central Bank (ECB) not only cut key interest rates, but also expanded the size and scope of its bond-purchasing program known as Quantitative Easing (QE).

With these policies, the ECB is trying to reflate the European economy, which is flirting with deflation. These monetary policies from the Fed and ECB could provide an extra boost to commodities in the coming months.

Not Just Gold and Gold Stocks
Gold and gold stocks have received a lot of attention because of their impressive performances so far this year. The yellow metal is up 18%.8 Gold miners, as a group, are up an incredible 41%.9 But, the truth is, we’re seeing a big rally across the commodity sector so far this year.

Lumber is up 18.6%; silver is up 10.24%; and platinum is up 7.14% as of March 23.10 Crude oil has rallied 50% since reaching the low price of $27 a barrel in February.11 And, since March 1, an ETF that tracks the performance of agricultural commodities such as corn, wheat, soy beans and sugar has increased by as much as 6.2% (as of March 22).12

The CRB Commodity Index has dropped 50% since peaking in 2014.13 So, could this short-term rally we’re now seeing be signaling the end of the great bear market in commodities?

Fig. #1
CRB Commodity Index 2013-2016

Source: Chart courtesy of Stockcharts.com.

(View a larger image here.) This is a trend definitely worth keeping an eye on. And, as you can also see in the chart, there may be plenty of upside potential. A big recovery could end up being one of the biggest market stories of 2016.

Until the next Daily Pfennig® edition…

Sincerely,
Mike Meyer
Vice President
EverBank World Markets, a division of EverBank
1.855.813.8484
everbank.com