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What Does the Decline in Commodity Prices Tell Us?

By: OptionsANIMAL
Posted: 4/18/2013 5:38:00 PM
Referenced Stocks: DBC;GLD

By Greg Jensen

It isn’t news to anybody who follows markets that commodities in general and gold in particular have taken a beating in the last week or so. There is no shortage of people telling us that this is the harbinger of a collapse in stock prices. I disagree. I have felt for a while that we are due, or even overdue, a correction in the stock market, but I can find little historical evidence that a quick decline in the price of gold or commodities in general signals a collapse.

Some point to 1980, when that pattern did emerge, but that looks more like an isolated occurrence than a reliable indicator. Take a look at the chart plotting the Powershares DB Commodity Index ETF (DBC) against the S&P 500 for the last five years.

 

In 2008, when the stock market began a severe decline commodities were still booming. DBC reacted to a drop in the stock market, not the other way round. Again in 2011, the stock market started to fall well before commodity prices. A look at gold, represented by the ETF GLD, year to date also shows little to no correlation, as you would expect.

 

GLD has been gradually declining all year before falling off a cliff last week, while the S&P 500 has been making steady gains.

This big drop seems to have been started by a big seller of gold on Friday. I have heard rumors that it was the Italian Central Bank, or the Bank of Japan, or China, or a US hedge fund. Whoever it was, the huge spike in volume would suggest that it was a real seller, not just market jitters. Commodities markets are futures based, so declines can be rapid and self-feeding. As the price falls, margin calls come in. This often means that contracts must be sold to cover those calls, putting more downward pressure on the market and creating a vicious circle. As gold fell, so other markets joined in. The price of oil was dragged down, with crude continuing a decline that started at the beginning of the month and falling to around $87 before recovering slightly on Thursday.

Lower prices for oil and industrial metals, even if only temporary as I suspect they will be, can be seen as a good thing for economic growth. If oil in particular stays lower, the resulting lower gas prices could well give a needed boost to US consumer spending.

Don’t get me wrong, it could well be that the correction in equities has started and a drop of another 4 or 5% wouldn’t surprise me at all. It is just that I don’t think the commodity price collapse is a sign of an even bigger fall. This just looks like a normal correction in the stock market and probably represents a good buying opportunity.