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Commodity Slump Part 2?

5 May 2017 by Mark Holman

The opening discussion on the desk today was not, for once, about politics or the current technical squeeze that we have been experiencing, but about the extended slump that we are seeing in commodity prices.

Naturally it has been the decline of WTI that has dominated the headlines, but both iron ore and copper have had material falls too. In fact the Bloomberg Commodity Index is now down 8% from its recent high water mark, which has virtually cancelled out the gains of last year. There are a number of contributing factors towards these various declines, but when we began to list them, they appear to be very similar to those that caused the commodity rout in Q4-2015.

So should we be worried? Should we be piling back into long duration bonds, as this was the stellar trade of the first month of 2016? Does this commodity sell off tell us something about aggregate demand? It certainly implies that there remains a firm lid on inflation.

Interestingly, bond yields in the risk-free sector have been creeping higher while this commodity weakness has been occurring, with US Treasuries at their highest yield in almost a month. So the market is confused and traditional correlations are not yet in sync. Credit markets which reacted very poorly in the prior commodity slump remain very resilient. So, at the moment, it is different and markets are currently prepared to overlook this commodity slump.

The last slump was painful for markets and particularly uncomfortable in certain industries and for individual companies, but ultimately markets shook it off and everything recovered in what turned out to be a huge buying opportunity. Second time round, events tend to be more muted as the results from the first round have already been seen. We have mentioned before that everyone wants to buy the dip, which will further underpin the market in this case.

Ultimately though, we do think things are different this time as markets have confidence in the global recovery with most corners of the globe pulling together. This really is the first time since the global financial crisis that both developed and emerging economies are growing steadily in unison.

So for now this commodity sell off might be a short term irritant and is certainly worth monitoring closely. But will it be the catalyst for a broader slump? We doubt it.

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