The U.S. stock market had one of its worst decades on record from 2000 to 2009, even worse than from 1930 to 1939, averaging just 1.2 per cent returns annually. Commodities, on the other hand, had a fantastic decade. U.S. stock markets had a great decade from 2010 to 2019, averaging 14.2 per cent annual returns. Commodities were pathetic.
We have witnessed a dramatic commodity boom and bust over these past 20 years.
Commodities all follow their own path short-term, but also tend to move in a similar direction in the longer term. When related commodities make short-term dramatic moves in opposite directions, active traders can be caught off guard, causing spectacular fund blow-ups.
Commodities are usually strongest late in an economic cycle. That could be good news for farmers currently suffering from depressed prices, and for the longevity of the existing economic cycle.
Corn, copper and oil
Corn Rallied from $1.25 to $4 prior to and during the 1973-74 recession, and from $2 to $4 prior to and during the double recessions from 1980-82. It did not rally appreciably for the 1990 or 2001 recessions but soared from $2 to $8 before and during the 2008-09 recession.
Copper is often referred to as Dr. Copper because it is frequently used as a gauge of economic activity. Copper rallied from $0.45 to $0.75 before and during the 1973-74 recession, from $0.50 to $1.30 prior to the 1980-82 recessions and from $0.60 to $1.50 prior to the 1990 recession, although in this case, it peaked a year before the recession. Its rally was relatively muted prior to the mild 2001 recession, rising from $0.60 to $0.90, but it flew from $1.20 to almost $4 prior to and during the 2008-09 recession.
Oil rose from $3.50 to $11 before and during the 1973-74 recession and from $15 to $40 in advance of the 1980-82 recessions. It went from $15 to $40, partly because of Gulf War One, peaking during the 1990 recession, and rallied from $11 to $33 before the 2001 recession. Oil skyrocketed for a half-decade peaking at almost $150 in 2008.
During a recession, commodity prices decline as demand moderates. The only times in modern history that energy demand declined were the severe recessions of 1980-82 and 2008-09. When economic recovery takes hold, commodity prices start to rally slowly as excess inventory dwindles. As the economic cycle matures, excess inventory has been removed and demand continues to grow, leading to price spikes and concerns of shortages. But contrary to what you hear at these times, the world never runs out!
In the spring of 2008, a farmer remarked that he had purchased a two-year supply of fertilizer because he was concerned about securing supplies in 2009. Similarly, in the late 1970s, there were serious concerns about gasoline supplies, causing line-ups and fights at U.S. filling stations. This fear caused drivers to fill up when they were half empty rather than empty, moving demand forward and causing further price spikes.
Commodities follow an inelastic demand curve, meaning it takes a big change in price to affect demand. If the price of diesel fuel goes from $1 to $1.50, you don’t change how much you use. Moving a small amount of demand forward adds to existing price pressures.
Commodity price spikes cause two things: Firstly, they are at least partially responsible for the economy entering a recessionary period as more consumer money goes to basic needs. Secondly, new supplies come on stream as commodity producers react to shortages and increase supply. This leads to declining prices, which are then partially responsible for an economic recovery. I use the word “partially” because there is never only one reason for anything, economically. To be continued in the next article.