Strengthening headwinds for commodities

I frequently highlighted the connection between the BDI and commodities as well as between commodities and government bond yields (see for example: Commodities and related markets to fall first? dated August 26). Following a sideways trading pattern between mid August and mid September, the BDI has fallen by another 12% over the past 10 days. I still think that a great part of the surge in the BDI during H1 this year and the subsequent rally in commodity prices was down to stockpiling, most notably by China. When this stockpiling faded, the BDI collapsed and in turn commodity indexes moved into a sideways trading behaviour. The latest fall in the BDI suggests that further downward pressure in commodity markets is upcoming - in line with my fundamental view.

Latest fall in BDI as a precursor for the fate of the commodity prices?

Source: Bloomberg, Research Ahead

On an individual commodity price level there area also some interesting developments. For example, oil prices have broken through an upward trend following the release of US inventories earlier this week which have increased significantly. Technically, it is too early to tell whether oil prices are at the start of a new downward trend or whether the sideways trading pattern of the past months continues. However, fundamentally I continue to look for lower prices as the rise in inventories seems to confirm my view that indeed end-demand remains subdued while spare capacity remains relatively high.

Oil prices have broken through their upward trend

Source: Bloomberg

Moreover, also copper shows signs of exhaustion following the doubling in prices up to end August and has since retreated by 10%. This is fairly important as industrial metals are the sub-component of the commodity index which have shown the largest performance since the start of the year. The chart below shows the various sub-components indexed at 100 at the start of the year. Agriculture and Livestock have both not contributed much to the general commodity price performance this year and a break-down in energy and industrial metals prices could bring a significant correction in the overall commodity indexes.

Industrial metals and energy products have been a key driver of overall commodity performance

Source: Bloomberg, Research Ahead

As suggested several times, commodities and government bond yields show a high co-movement at present and a significantly different picture than the development of equity markets. This should not be that surprising given that lower commodity prices would go hand in hand with low headline inflation and therefore low nominal growth. Nominal growth, however, is the key driver for the longer term development of nominal government bond yields.

Ongoing co-movement of commodities and government bond yields

Source: Bloomberg, Research Ahead

Overall, fundamental headwinds for commodity prices remain substantial and the technical situation for energy products as well as industrial metals is weakening. I stick to my view from late August where I stated that timing wise we should see commodity markets to start falling which will spill over into commodity economies' equity markets and be followed by developed equity markets moving lower as well.
On the other side, the fundamental environment for government bonds remains supportive and I continue to expect a break lower in government bond yields over the next days/weeks.