The recent downturn in commodity prices has caught many off guard. Not only did the price of gold decline, but the prices for essential metals and oil also took a significant hit. Last Thursday, copper plummeted nearly 2 percent, reaching its lowest point since 2009.
Iron ore prices have also seen a decrease, and oil has fallen below the $50 per barrel threshold. However, the downturn may not be over yet.
According to experts at Morgan Stanley, the current crash in oil prices could mark the most severe decline in over 45 years. The reasoning is straightforward: typically, during a downturn in oil prices, production is reduced, leading to a natural decrease in supply.
This decline in supply normally paves the way for prices to recover. Yet this time, as oil prices continue to fall, supply has surprisingly increased, creating a situation that defies logic.
Following the price collapse earlier this year, U.S. oil production stabilized, which was expected. However, contrary to expectations, OPEC has not scaled back production; in fact, it has risen from approximately 30.5 million barrels per day in January to over 32 million barrels per day in June. What could explain this unexpected trend?
This Wasn’t Supposed to Happen
Morgan Stanley’s analysts are currently maintaining their belief that oil prices will eventually rise again. They cite the limited spare capacity within OPEC and the substantially decreased oil stocks as driving factors in their forecast, as reported by Bloomberg.
Nonetheless, new supply sources from outside the U.S. could continue to emerge, especially if sanctions against Iran are lifted or if conditions in Libya improve. This raises doubts about a swift recovery—Morgan Stanley analysts suggest that the downturn might persist for over three years, potentially even worse than the slump in 1986.
As they noted, “In that case, there is little historical precedent to guide what lies ahead.”
If additional supply enters the market while prices are declining, it could drive prices even lower. However, it raises the question: what motivation is there for increased supply under such circumstances? It’s puzzling, to say the least.
We cannot overlook the possibility of further production increases. The unexpected surge in production over the past few months was not anticipated, yet it happened, indicating potential continuation.
Since their peak of $107 per barrel in June 2014, oil prices have dropped around 55 percent. Yet throughout this downturn, production continues to rise. “We’re navigating uncharted waters with inventories accumulating at this time of year,” remarked John Macaluso, an analyst at Tyche Capital Advisors.
The Perfect Storm Bearing Down Upon Us
However, the underlying issue goes beyond declining commodity prices. The real concern lies in the stagnation of the global economy, where demand for oil and raw materials is vanishing.
If the global economy were robust and flourishing, we would see a rise in demand for commodities. Consequently, one would expect commodity prices to follow suit. The falling prices are a clear signal that the global economy is cooling off.
“This commodity bear market is unfolding like a train wreck in slow motion,” said Andy Pfaff, the chief investment officer for commodities at MitonOptimal in Cape Town. “It possesses tremendous momentum and doesn’t halt abruptly.”
Investors are fleeing from raw materials as the Federal Reserve edges closer to raising interest rates and as economic growth in China—the largest consumer of commodities—remains sluggish, at its slowest pace since 1990. Weak demand from other emerging markets and the prospect of increased oil supply contribute to the negative sentiment, which UBS Group AG strategist Julian Emanuel has dubbed a ‘perfect storm.’
A perfect storm refers to a rare convergence of events leading to an extraordinary situation. Here at Economic Prism, we remain vigilant and prepared, ensuring our rigging is secure as we brace for the upcoming perfect storm.
Sincerely,
MN Gordon
for Economic Prism
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