By David Sterman
Although the U.S. stock market has generated a healthy glow this year, the commodity complex appears to be entering into a growling bear market. Just consider these stats:
After a sharp drop on April 15, gold has plunged nearly 20% since the year began and nearly 30% since hitting an all-time high of around $1,900 per ounce in the autumn of 2011.
West Texas crude oil has slipped from $97 per barrel to $87 in just the past two weeks. Copper has slid roughly 12% this year and is off roughly 27% since the summer of 2011 peak. If aluminum breaches the 80 cents per pound mark (it's currently at 82 cents), it will see its lowest levels since the summer of 2009.
Unless these commodities quickly stabilize, they will all start to break key resistance levels and head even lower. Yet it's unwise to lump all commodities together, and the factors affecting one of them is quite distinct from all others.
The sliding yellow metal
Perhaps the most vulnerable commodity of all is gold, which has no supply-and-demand mechanisms to help establish a fair value. The price of gold has always been based purely on sentiment, mostly as a perceived hedge against eventually ruinous inflation.
Yet an April 10 report by Goldman Sachs has led even the most avid gold bulls to question their inflation-protecting stance. Goldman's analysts took note of the fact that as the recent crisis in Cyprus unfolded, gold prices barely budged, which stands "in sharp contrast to the larger USD gold moves observed during the last quarter of 2011, when fears that Greece would leave the euro area were at their highest," Goldman's analysts note.
The key conclusion: The notion that gold is a valued hedge in these complex economic times is no longer applicable. And it's time for gold to start trading on the fundamental dynamics of supply and demand. Although Goldman's analysts see gold remaining above $1,400 this year, they expect the yellow metal to move below $1,300 next year. Their long-term forecast for gold: $1,200 an ounce.
Why that price?
"Inflation expectations remain well anchored, and our economists expect subdued inflationary pressures in coming years," Goldman's analysts say.
They figure $1,200 an ounce for gold is fair value if inflation remains tame. And gold investors are now realizing that the longer it takes for any inflation to appear, the less patience even the most avid inflation hawks will have to stick with this trade. So the exodus in gold is a sign that some investors are heading for the exits before even more do so.
Central banks are still buying gold and have accelerated their purchases during the past three months. Goldman's analysts say that trend will continue, but they figure gold would likely move even lower than their forecast of $1,200 per ounce were it not for the central banks' purchases. On the other hand, consumer demand for gold in China and India appears to be slumping, which is why gold has been hit especially hard in the past few trading sessions.
"Gold investments are increasingly looking like a bubble ... and long-term investors will look to book their profits in the current market environment," said Mohit Khamboj, president of the India-based Bombay Bullion Association, in an interview with The Wall Street Journal.
The fact that many gold producers, such as Barrick Gold
), are beset by their own company-specific mining problems right now just adds pain to gold investors.
What about other commodities?
The simultaneous sell-off in other commodities may be somewhat coincidental. The price drops in oil, copper, aluminum and other commodities is more closely tied to global economic demand, especially from China. In this column
on TheStreetAuthority from late March, I noted that weak economic data in China thus far in 2013 appears to be driving the commodity sell-off. China's gross domestic product grew a reported 7.7% in the first quarter, below the consensus forecast of 8%. And as long as the possibility remains that the Chinese economy will slow yet further in current quarters, commodity prices could keep falling.
That's the view of Citigroup's economists, who just lowered their price forecasts for several commodities. For example, they see copper sliding to $3.07 per ounce by next year (from a recent $3.24), which would be the lowest level in nearly three years.
And whereas Citi's economists expected to see aluminum prices rebound to 99 cents per pound in 2014, they've just revised that figure to 88 cents.
Still, these are the kinds of commodities you need to keep tracking, because lower prices counterintuitively set the stage for the next bull market in commodities. For example, consider iron ore.
Iron ore surged from $60 per metric ton in the summer of 2008 to nearly $190 per ton in February 2011, thanks to firming global demand in places like China and the United States. Trouble is, iron-ore producers took note of the firming prices and aggressively boosted their mining activities. It soon became clear that too much supply was heading to the market, and iron ore prices slumped below $100 per ton by the summer of 2012.
That led major producers such as Cliffs Natural Resources
) and others to start cutting back on their production plans. As a result of reduced supply forecasts, iron ore prices have rallied by roughly 40% since last summer, to around $140 per ton. We've seen a similar supply-induced relief rally in natural gas during the past year as well.
Action to Take: And that's precisely the dynamic you will see play out with other commodity producers. Today's pain will bring supply discipline, and as supply falls to -- or even below -- the levels of demand, then the stage will be set for the next commodity upturn. We're not there yet, but it pays to track the production plans of the top producers of copper, aluminum and other key commodities. Although analysts are bracing for a prolonged slump, they'll change their tune as soon as they see a change in production.
Risks to Consider: Trying to bottom-fish these commodities can be perilous. The global economy remains unhealthy, and China and the U.S. in particular could start to feel the gravitational pull of weakness in Europe and elsewhere.
David Sterman does not personally hold positions in any securities mentioned in this article.
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