Should Investors Worry About Yesterday's Commodities "Tumble"?

Most of the attention retail investors pay is on the stock market. This makes sense, because that is where they generally invest their money. Sometimes, the more interesting and informative moves come in other markets. The challenge is that most people's takes on things like forex and commodities come only from headlines, and they can be extremely misleading. Yesterday, for example, CNBC led with "Commodities from copper to corn tumble on China crackdown, rising dollar," which is pretty scary ... until you understand the potential impact of China’s crackdown and put that move in context.

It is not inaccurate to say that commodities "tumbled" yesterday. Copper lost close to 5%, with other metals doing even worse on the day. Palladium, for example, fell around 11%. Nor was the situation any better in other areas of the commodity markets. Corn, lumber, soybeans, gold, and crude all fell dramatically and, coming as it did after stocks lost ground on the Fed announcement, I am sure to many investors it feels like some kind of a meltdown in markets.

What it really is, though, is a rational response to a kind of perfect storm for commodities. The two reasons for the weakness would have caused some weakness in markets on their own but coming at the same time, that weakness got exaggerated.

The Chinese government has been rumbling for some time about raw material prices and, unlike in free market economies, they feel that it is their responsibility and within their power to do something about it. They attacked the problem on two fronts, releasing reserves of copper, aluminum and zinc on Wednesday, and launching a crackdown on speculative positions by futures trading firms and state owned enterprises. Both those things will have an impact, but that impact won’t be sustained in either case.

Releasing reserves will temporarily address some supply/demand imbalance in China, but the inability of suppliers to keep up with increasing post-pandemic demand is a global problem and isn’t going anywhere. Take a look at the 60-day chart for Comex copper stocks below, and you can see that quite clearly:

And while the Chinese government may be able to squeeze speculative buyers in a way that regulators here probably wish they could, that too will have only a short-term impact. Forcing somebody to take a profit on a trade may put downward pressure on prices for a while, but it just gives them more ammunition for their next speculative trades. As long as demand is outstripping supply, they will simply be buyers again next time and the price drops will be temporary.

The other reason cited for the commodity “rout” yesterday -- a higher dollar -- could theoretically have a longer-term impact on commodity pricing if it continues, and there is a good chance it will. It came in response to the Fed suggesting that they may look at rate hikes in 2023, a bit earlier than previously forecast. As long as there is the prospect of a rate hike out there, the dollar will be in demand, but that doesn’t mean that commodities are about to collapse. Over the course of a year or so, sustained dollar strength may push prices a bit lower, but for now, increasing demand and restricted supply are far more important factors, and they suggest further gains.

As striking as yesterday’s price action was, it is not all that significant when put against the backdrop of the massive gains in commodities over the last year or so. Corn is still up around 90% compared to a year ago, and copper closed yesterday with a 67% 52-week gain. Right now, this looks more like consolidation than collapse, no matter what the headlines might say, and the chances of it creating a panic in the stock market are slim at best. Keep an eye on it, by all means, but don’t overreact at this point.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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Commodities Economy