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What Can We Expect Next From Commodities? – A Q&A with Resources Expert, Dr Alex Cowie.


Written on 03 October 2011 by Dr. Alex Cowie

What Can We Expect Next From Commodities? – A Q&A with Resources Expert, Dr Alex Cowie.

Introducing Professor Manganese: Q&A with Resources Expert, Dr Alex Cowie

Q: Copper has taken a bit of a smashing recently…what’s going on there? And do you still like ‘the red metal’

It’s not just copper. Nearly all commodities have ‘copped it’ in the last month

You can see this by looking at how the commodity indices have taken a belting recently. The ‘Continuous Commodity Index’ takes in 17 different commodities. This index fell as much as 13% in September.

Continuous Commodity Index – down 13% in a month
Continuous Commodity Index - down 13% in a month
Source: Bloomberg

So what caused the heat to come out of the market so quickly?

The commodities that make up a big chunk of this index, such as oil and copper, are heavily financialised. By this I mean a great deal of the commodity’s value is determined by financial players, rather than manufacturers and users. Instruments like Futures and Exchange Traded Funds let the market push the price of copper up and down, for example.

It’s hard to say exactly, but it seems that about a quarter of the price of copper comes from this financialisation. And if the market is having a tough time, traders and funds can quickly cause a fall in commodity prices by selling these instruments. Even though none of them would know a copper ingot if it ran into their kitchen and bit their knees off.

I’ve been using copper as a forecasting tool for years, but, because of these distortions, I am starting to ask questions about how good it is.

So it’s good to keep an eye on other commodities that don’t have these confusing influences. Traditionally copper has been called ‘Dr Copper – PhD in Economics’ as it picks the direction of economic growth. But this financialisation may have made the good doctor a bit unreliable.

Q: So if copper is distorted then what do else do you look at?

I’d like to introduce you to ‘Professor Manganese’

This metal is mostly used in steel making, so is a rough indicator of what direction global economic growth is going. It also has a simple market. No traders are out there ‘shorting 50 December 2013 manganese future contracts’ or ‘arbitraging between Chinese and US manganese ETFs’.

Producers make the stuff – and buyers use it. It’s an honest metal.

And manganese prices have actually been rising slowly for most of this year. It’s not enough to shout from the rooftops about, but it is something positive to keep an eye on.

 

 

‘Professor Manganese’ may be a better economic
indicator – and it is creeping up

metal price chart

Source: metalprices

 

 

Q: That must be one of the few indicators pointing up at the moment. Can you see any others?

There aren’t many, and it’s easy to miss them when the headlines are filled with bad news from Europe and the US.

But when everyone else was focused on the footy over the weekend, I noticed China’s Purchasing Managers Index (PMI) turn up quietly. (I’m an exciting guy… what can I say!)

The PMI is a measure of Chinese industrial production levels, new orders from customers, speed of supplier deliveries, inventories and employment levels.

So it is worth keeping an eye on, as it gives a good idea of what to expect next from economic growth and also commodity demand in the coming months.

 

 

Chinese PMI is creeping back up again

Chinese PMI is creeping back up again
Click here to enlarge

 

 

Source: forexfactory

 

What’s interesting is that the PMI chart for this year has done a very similar thing to last year: a dip in March, then a rally, then a dip in August, followed by a recovery. If the script holds true then we should see the PMI keep rallying for the next four or five months.

It’s not just China though. In last week’s fog of bearishness, the market missed the fact that Chicago’s PMI turned up as well. This gives us a good idea of what is happening to US industry.

One month is not a trend, but this month’s increase is good news all the same. The index is also doing similar things to last year. This may be because of seasonal factors. If it is, then we may be looking at the start of a rally here too.

 

 

Chicago PMI turning back up as well

Chicago PMI turning back up as well
Click here to enlarge

Source: forexfactory

 

If this really is the start of a trend for China and Chicago’s PMIs , then we should see commodity prices start to recover by year’s end.

This would be great news for resource stock investors who have had a tougher year than most.

Q: But hasn’t gold been a good place to invest again this year?

Gold got as high as US$1932 last month, and was looking ready to crack US$2000.

It has pulled back since then to the low US$1600s. The recent drop may have investors rattled, but the fact is that it is still up 15% for the year. That’s a return you won’t find in many other places in this market!

All that the fall in gold price does is to bring it back to its long-term trend. It is now hovering around gold’s 120-day moving average. This is a technical level that has often given support whenever the price has pulled back in the last few years. I’ve marked it on the chart below.

 

 

Gold finding support at the 120-day moving average

Gold finding support at the 120-day moving average
Click here to enlarge

Source: stockcharts


Q: So what happens next for gold?

I’d be happy to see gold spend a bit of time at this level. The more it consolidates here, the better the chart looks.

I’m not sure it will have too long to settle though! The case for a rising gold price is as strong as ever. Government debt levels are still rising, and central banks are increasing the money supply. Meanwhile gold is in limited supply and miners produce less each year.

Adding to this we now have the European bailout fund getting closer to increasing to two trillion Euros! This will involve increasing debt levels, and can only be positive for gold prices.

We recently had the Fed announce Operation Twist. The market hasn’t been excited about this at all, and no one expects it to drive markets much.

The Fed starts Operation Twist in the States tonight, and it will last for the next nine months. The Fed won’t increase its balance sheet in the process, in other words there is no ‘money printing’. But at the same time, it will overall reduce the money making opportunities in the bond market. In turn this will push investors into riskier investments than normal.

I think that the market may be surprised at the effect the Twist has on the market. Last time it was put into play during the 1960s, the market rose 50% over the two years it was in effect.

But with money being forced to look for a home elsewhere, and not much yield available in the bond market, I think the real winner will be the gold price.

If the last few pullbacks in gold are anything to go by, gold may spend another week or two at this level.

After that, I think we will see the next steady climb, which will almost certainly take the price north of $2000.

Publisher’s note: Dr. Alex Cowie holds a Graduate Degree in Finance and Investment from the Financial Services Institute of Australia – which he puts to good use as editor of Diggers and Drillers – Australia’s premier resource stock advisory. Alex’s job is to travel the globe looking for the Aussie resource stories that are yet to be told… then tell them to his readers. You can get a look at what’s on his radar right now by going here.



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1 Comments For This Post

  1. SV Says:

    So when oil and copper drop, we will look at another indicator.
    Why does the manganese price rise? Is this because of the increasing steel production? But we are told that is not sustainable because all that steel goes into empty buildings.
    And if it because of the drop in supply, what does it tell you about other commodities? nothing I guess.



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