Sunday, December 20, 2015

Who's right, commodities or the Fed?

As the U.S. Federal Reserve Bank raised interest rates last week for the first time in 10 years in response to what it said was strength in the U.S. economy, economically sensitive commodities such as industrial metals and crude oil continued to plumb new cycle lows.

Either these commodities are about the turn the corner as renewed strength in the United States--the biggest buyer of commodities next to China--revives industrial metal and crude oil demand--or the Federal Reserve is misreading the tea leaves and crashing commodity prices signal a world and U.S. economy in distress.

Market analysts like to say that copper is the metal with a Ph.D. in economics. Because of copper's central role in the modern economy, it often reliably forecasts the direction of the economy. Since copper reached its peak at the beginning of 2011 above $4.50 per pound, it has swooned to near $3 in 2011 coinciding with a crisis in Europe, bounced back to near $4 once the crisis passed and then settled above $3 by the middle of 2013 where it essentially traded sideways until this year. After trending down since May copper hit $2.05 a pound last week, only three cents above the low for the year registered on November 23.

And, it wasn't just copper. Nickel started the year above $7 a pound and finished last week at $3.90 a pound. Aluminum began the year above 90 cents a pound and settled last week at 67 cents. Zinc peaked near $1.10 a pound in May and now sells for 66 cents. Iron ore prices, which dropped almost 50 percent last year, this year dropped from $68 per ton to $47 as of last week, another 31 percent decline.

Crude oil, which dropped about 50 percent in the last half of 2014, has dropped another 35 percent so far in 2015.

So, given this picture of the price trends for basic materials which are key to the economy, why has the Fed concluded that now is the time to start raising rates?

A clue comes from the analysis of Doug Noland who has been following what he calls the greatest credit bubble of all time. Noland explains that the swoon of emerging market countries--which include commodity producing economies such as Brazil, Russia, Mexico and other mineral and petroleum exporting nations--has sent money scurrying to what he calls "the core," the United States, Europe and Japan. For a while this flow will buoy these core areas by injecting money into their economies and stock markets.

Eventually, the financial rot in "the periphery," the emerging market countries mentioned above, will reach the core and slow their economies while threatening their financial institutions which hold increasingly shaky debt from periphery countries.

Already indicators show that world trade is slowing as the Baltic Dry Index, which measures shipping costs, crashes to new lows. U.S. manufacturing is now in recession creating "the worst manufacturing climate since March 2009."

It is always darkest before the dawn, the saying goes. When referring to his own worst investment decisions, legendary fund manager Peter Lynch loved to parody that saying with this rewrite: It is always darkest before it goes pitch black.

In February, I suggested that the already significant decline in commodities was signaling a weak world economy. Since then commodity prices have weakened again and dramatically so. And yet, the stock markets and economies in the "core," the United States, Europe and Japan, seem to be defying the trend in commodities just as the Fed pronounces the U.S. economy healthy enough for a rise in interest rates.

Either commodities are correctly forecasting the direction of the overall world economy or the world's "core" economies are about to lead the world economy back toward faster growth. The outcome will determine the fate of trillions of dollars of investments premised on the idea that one of these indicators is right.


For my take on last week's repeal of the U.S. oil export ban, see my piece from September entitled, "Truth takes a hit in battle over U.S. oil export ban." The ban was lifted as part of a huge federal spending bill in which supporters of renewable energy got renewed tax credits for solar and wind power in exchange for accepting repeal of the ban.

Kurt Cobb is an author, speaker, and columnist focusing on energy and the environment. He is a regular contributor to the Energy Voices section of The Christian Science Monitor and author of the peak-oil-themed novel Prelude. In addition, he has written columns for the Paris-based science news site Scitizen, and his work has been featured on Energy Bulletin (now, The Oil Drum,, Econ Matters, Peak Oil Review, 321energy, Common Dreams, Le Monde Diplomatique and many other sites. He maintains a blog called Resource Insights and can be contacted at

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