Up and Down Wall Street
Commodities, China and Greece Hint at Deflation
Like a falling barometer, sliding commodity prices can often signal an approaching storm for investors.
By Randall W. Forsyth
Updated July 7, 2015 6:50 p.m. ET
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The contagion from the crisis in Greece and the crash in China to other major securities markets so far has been relatively muted. The far greater impact appears to be in commodities, which have fallen hard this week. Losses have been across the board, from crude oil to corn.
And while there hasn’t been any single, strong linkage from the commodity pits to the tumult in Athens and Asia, the decline shouldn’t be ignored. Like a falling barometer, sliding commodity prices can often signal an approaching storm.
Over the past four sessions, nearby Nymex crude oil futures plunged over $7 a barrel, or 12%, to $52.33, the lowest since mid-April. Copper, the metal with a putative Ph.D. in economics, took a 3.6% hit Tuesday and was off 7% in the past three sessions to a 52-week low of $2.4510 a pound, while Freeport-McMoRan fell a similar amount and hovered just above the 52-week high touched in January. Iron ore entered a bear market, losing 20% since its June 11 high, according to Bloomberg, while aluminum, lead and platinum also slumped. Grains and soybeans also took a tumble, so it wasn’t just industrial commodities getting hit.
These declines suggest a broader deflationary trend, which was corroborated by gold’s renewed slide after barely treading water despite the heightened fear and uncertainty that historically has helped the precious metal. As I have argued in these columns previously, gold is more a currency than a commodity, and its value depends on the public’s perception of paper money. Illiquidity heightens demand for currencies (to pay back loans, for instance) and raises their value relative to gold, depressing the metal’s price.
Regardless of the reason, the SPDR Gold Shares exchange-traded fund shed another 1% Tuesday to trade about 1% above its 52-week low while the Market Vectors Gold Miners ETF tumbled 3.9% to about 4% from its 52-week low. And silver fell to a five-year low Tuesday, settling at $14.969 a troy ounce. The iShares Silver Trust ETF sank 3.7% to close at $14.43 after falling to as low as $14.03.
Although it’s impossible to pinpoint the source of the deflationary winds, there is little question about the direction they’re blowing.
While the media’s attention has been concentrated on Greece, Renee Haugerud, who heads the commodity-oriented Galtere hedge-fund group, has been feeling folks have been looking at the wrong places. While she admits that there are no data to back up her “gut” feel, it appears the selling of commodities is related to China’s stock rout.
But Haugerud is quick to dismiss market rumors that China’s authorities are dumping commodities to pump cash into its stock market. More likely, she says, traders who have gotten hurt by the slide in Chinese stocks may have had to liquidate other assets, such as commodities, to meet margin calls. That’s been exacerbated by suspension of trading in hundreds of stock, some 162 issues in Shanghai and 514 in the even more speculative Shenzhen market. When you need cash, you sell what you can, not what you want to sell.
Moreover, she continues, commodities provided the collateral for loans to fund other activities, including stock purchases. Crude oil, copper and, to a lesser extent, soybeans have been liquidated to pay back those loans. That process is perhaps three-quarters over, Haugerud adds.
There also are fundamental reasons for agricultural prices to fall. As a proud Midwestern farmer’s daughter, she monitors the crops from a working farm in the heartland, and she sees a bumper crop for corn this year. Ample supplies of grains and soybeans are pressuring their prices, which is about as straightforward as markets get.
The deflationary impact from Greece is less simple. Charles Gave, whose name forms the first half of Gavekal Dragonomics, suggests that a Grexit would exert deflationary pressures—in contrast to the inflation that has historically followed a currency devaluation, which would be the effect of a reintroduction of the drachma.
As Gave explains in a note to clients, 75% of Greece’s 315 billion euros of foreign debts is owned by public institutions—the International Monetary Fund, the European Central Bank and various European Union groups. A write-down of that debt would have deflation impacts.
A 50% write-down in the Greek debt would “dent” the IMF’s capital, which would not likely to be topped up by the U.S., the largest shareholder in the Fund. That would curtail the IMF’s ability to intervene in future crises—which would be highly deflationary, according to Gave.
Also facing a big hit to capital would be the ECB, which is owned by the EU central banks. Gave imagines the Bundesbank wouldn’t pump in additional German taxpayer funds into the ECB, which would violate Germany’s constitution. That constraint also would be highly deflationary in restricting the ECB’s lending.
Finally, Gave writes: “The alphabet soup of institutions and lending programs created by those ever-so-smart Eurocrats to help finance Greece all amount to the same thing: these entities are highly rated by the big ratings agencies and have issued lots of bonds bought by the world’s major financial institutions.
Unfortunately their assets are mostly parked in Greek paper, with a small amount of Spanish and Portuguese bonds thrown in for good measure.” That’s analogous to Fannie Mae and Freddie Mac, the big U.S. mortgage agencies’ implied federal guarantee.
If European governments are forced to recognize their holdings of Greek obligations as part of their own debt by credit agencies, they may “clamor for more tax hikes and government spending cuts”—also deflationary.
All of which is admittedly speculative. What is clear is that neither the Greece crisis nor China’s stock slide is positive for the world economy. At a minimum, commodities’ signal is consistent with that.
An employee inspects freshly picked ears of bi-color sweet corn at the Scotlynn Sweet Pac Growers packing facility in Belle Glade, Florida. Photo: Mark Elias/Bloomberg
And while there hasn’t been any single, strong linkage from the commodity pits to the tumult in Athens and Asia, the decline shouldn’t be ignored. Like a falling barometer, sliding commodity prices can often signal an approaching storm.
Over the past four sessions, nearby Nymex crude oil futures plunged over $7 a barrel, or 12%, to $52.33, the lowest since mid-April. Copper, the metal with a putative Ph.D. in economics, took a 3.6% hit Tuesday and was off 7% in the past three sessions to a 52-week low of $2.4510 a pound, while Freeport-McMoRan fell a similar amount and hovered just above the 52-week high touched in January. Iron ore entered a bear market, losing 20% since its June 11 high, according to Bloomberg, while aluminum, lead and platinum also slumped. Grains and soybeans also took a tumble, so it wasn’t just industrial commodities getting hit.
These declines suggest a broader deflationary trend, which was corroborated by gold’s renewed slide after barely treading water despite the heightened fear and uncertainty that historically has helped the precious metal. As I have argued in these columns previously, gold is more a currency than a commodity, and its value depends on the public’s perception of paper money.
Regardless of the reason, the SPDR Gold Shares exchange-traded fund shed another 1% Tuesday to trade about 1% above its 52-week low while the Market Vectors Gold Miners ETF tumbled 3.9% to about 4% from its 52-week low. And silver fell to a five-year low Tuesday, settling at $14.969 a troy ounce. The iShares Silver Trust ETF sank 3.7% to close at $14.43 after falling to as low as $14.03.
Although it’s impossible to pinpoint the source of the deflationary winds, there is little question about the direction they’re blowing.
While the media’s attention has been concentrated on Greece, Renee Haugerud, who heads the commodity-oriented Galtere hedge-fund group, has been feeling folks have been looking at the wrong places. While she admits that there are no data to back up her “gut” feel, it appears the selling of commodities is related to China’s stock rout.
But Haugerud is quick to dismiss market rumors that China’s authorities are dumping commodities to pump cash into its stock market. More likely, she says, traders who have gotten hurt by the slide in Chinese stocks may have had to liquidate other assets, such as commodities, to meet margin calls. That’s been exacerbated by suspension of trading in hundreds of stock, some 162 issues in Shanghai and 514 in the even more speculative Shenzhen market. When you need cash, you sell what you can, not what you want to sell.
Moreover, she continues, commodities provided the collateral for loans to fund other activities, including stock purchases. Crude oil, copper and, to a lesser extent, soybeans have been liquidated to pay back those loans. That process is perhaps three-quarters over, Haugerud adds.
There also are fundamental reasons for agricultural prices to fall. As a proud Midwestern farmer’s daughter, she monitors the crops from a working farm in the heartland, and she sees a bumper crop for corn this year. Ample supplies of grains and soybeans are pressuring their prices, which is about as straightforward as markets get.
The deflationary impact from Greece is less simple. Charles Gave, whose name forms the first half of Gavekal Dragonomics, suggests that a Grexit would exert deflationary pressures—in contrast to the inflation that has historically followed a currency devaluation, which would be the effect of a reintroduction of the drachma.
As Gave explains in a note to clients, 75% of Greece’s 315 billion euros of foreign debts is owned by public institutions—the International Monetary Fund, the European Central Bank and various European Union groups. A write-down of that debt would have deflation impacts.
A 50% write-down in the Greek debt would “dent” the IMF’s capital, which would not likely to be topped up by the U.S., the largest shareholder in the Fund. That would curtail the IMF’s ability to intervene in future crises—which would be highly deflationary, according to Gave.
Also facing a big hit to capital would be the ECB, which is owned by the EU central banks. Gave imagines the Bundesbank wouldn’t pump in additional German taxpayer funds into the ECB, which would violate Germany’s constitution. That constraint also would be highly deflationary in restricting the ECB’s lending.
Finally, Gave writes: “The alphabet soup of institutions and lending programs created by those ever-so-smart Eurocrats to help finance Greece all amount to the same thing: these entities are highly rated by the big ratings agencies and have issued lots of bonds bought by the world’s major financial institutions.
Unfortunately their assets are mostly parked in Greek paper, with a small amount of Spanish and Portuguese bonds thrown in for good measure.” That’s analogous to Fannie Mae and Freddie Mac, the big U.S. mortgage agencies’ implied federal guarantee.
If European governments are forced to recognize their holdings of Greek obligations as part of their own debt by credit agencies, they may “clamor for more tax hikes and government spending cuts”—also deflationary.
All of which is admittedly speculative. What is clear is that neither the Greece crisis nor China’s stock slide is positive for the world economy. At a minimum, commodities’ signal is consistent with that.
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